Many business owners and individuals incorrectly believe they can charge any amount of interest to which the parties agree. However, unlike many contract terms, rates of interest charged by non-exempt lenders is limited in California to ten percent (10%) per year, even if the borrower is otherwise willing to pay a higher rate (or begs for a higher rate). If your promissory note or loan agreement exceeds this rate, then it is usurious unless it fits within one of the exemptions, set out below. As a non-licensed lender considering charging a higher rate, any credible business lawyer will have this advice: “Don’t do it!” The risk for civil damages and even criminal charges being brought against you is very real.
What is Usury?
Simply put, usury is the charging of interest beyond the rate permitted by California law. In other words, any rate beyond that set by state law is considered usurious and unenforceable. To prevent lenders from usurping the intent of usury laws by characterizing “interest” as other fees, bonuses, or miscellaneous charges, our courts have typically interpreted the term broadly to include anything of value that is received directly or indirectly by the lender from the borrower regardless of the nature or form of the consideration.
Non-exempt lenders may charge a maximum of (i) 10% interest per year (1% per month) for money, goods or things used primarily for personal, family or household purposes; or, (ii) for other types of loans (home improvement, home purchase, business purposes, etc.), the greater of 10% interest per year, or 5% plus the Federal Reserve Bank of San Francisco’s discount rate on the 25th day of the month preceding the earlier of the date the loan is contracted for, or executed. Any consideration charged on a loan by a non-exempt lender which exceeds these rates is usurious and may lead to legal action against the lender.
California usury laws can be found in various sections of the California Civil Code and the California Constitution, including:
- California Const. Art. XV §1 (Previously passed as Art. XX §22)
- California Civil Code §§1912-1916.12
- California Civil Code §§1916-1 to 1916-3 (Constitutional provisions implemented here)
- California Civil Code §§1917-1917.006
- California Civil Code §§1917.060-1917.069
- California Civil Code §§1917.160-1917.168
- California Civil Code §§1917.610-1917.619
- California Commercial Code §§9201-9208
- California Corporations Code §§25116-25118
- California Financial Code §§22000-22064
- California Government Code §§5900-5909
Note: Cal. Civ. Code §1916-1 permits a maximum interest rate of 12% per annum. However, it is presumed that the 10% maximum of the Constitution at Art. XV §1 would prevail where a conflict arises.
Remedies for Usurious Interest Rates
The previously cited Constitutional provision clearly states that usurious contracts are unenforceable, raising the possibility that the lender may not be able to recover its principal. However, California courts have held that wherever possible, a contract will be construed so as to make its effect non-usurious. See Thomassen v. Carr, 250 Cal. App. 2d 341 (1967). In addition, the underlying intent of the usury laws are to prevent a lender any excessive profit, not their principal.
Nevertheless, applicable sections of the California Code go further than disgorging unlawful interest by assessing civil and even felony criminal penalties against lenders who violate usury laws. Section 1916-2 of the Civil Code can work to prevent a lender from collecting any interest on a loan that contains a usurious rate of interest, as well as delay repayment of the loan principal. It provides, in relevant part:
Any agreement or contract of any nature in conflict with the provisions of this section shall be null and void as to any agreement or stipulation therein contained to pay interest and no action at law to recover interest in any sum shall be maintained and the debt can not be declared due until the full period of time it was contracted for has elapsed.
Subsection 1916-3(a) further provides for treble damages for usurious payments and Subsection (b) allows for criminal penalties as well:
(b) Any person who willfully makes or negotiates, for himself or another, a loan of money, credit, goods, or things in action, and who directly or indirectly charges, contracts for, or receives with respect to any such loan any interest or charge of any nature, the value of which is in excess of that allowed by law, is guilty of loan-sharking, a felony, and is punishable by imprisonment in the state prison for not more than five years or in the county jail for not more than one year.
Depending on the nature of the lender, any willful violation of the usury laws may also be a violation of Business & Professions Code §17000, et. seq., which exposes a lender to criminal liability. In sum, our business lawyers advise non-exempt lenders to steer clear of charging usurious interest rates, which can ultimately cost them significant amounts of money and their freedom, or consider fulfilling the criteria of one of the many exemptions which permit lenders to charge higher rates of interest.
California Usury Law Exemptions
Following are a brief description of some exemptions to California’s usury laws:
- Licensed Lending Institutions: Licensed lending institutions engaged in the business of making consumer and/or commercial loans such as banks, savings and loans, credit unions, finance companies, horticultural or dairy cooperative associations, bank holding companies and their subsidiaries, and pawn brokers are exempt from California’s usury laws (although regulated through other laws, including federal law). See California Financial Code §5102, §7675 §15000, §21000, §21200, §22002, §22009, §22303, and §28000; Home Owners Loan Act of 1933, 12 U.S.C.A §1464(5)(c)(4)(B) and the Building and Loan Association Act of 1931 (as amended).
- California State and Local Public Retirement Systems
- Loans Secured by Real Property or Used to Purchase, Build, or Improve Real Property: If properly originated and negotiated, such loans are typically exempt when made or arranged by a licensed real estate broker. See California Civil Code §1916.1.
- Seller Financing – Seller Carryback Loans: When a seller of real estate finances the purchase for the buyer with a note secured by a deed of trust, the financing is commonly referred to as a seller carry back loan.
- Most Retail Installment Contracts and Revolving Accounts: Some types of these contracts/accounts are regulated by industry specific laws.
- Credit Cards
- Licensed Pawnbrokers: Regulated by California Financial Code §21000, et seq.
- Loans to Certain California Businesses: See California Corporations Code §25118.
Whether you are a borrower or lender, it pays to reach out to an experienced business lawyer beforehand in order to avoid the potential for costly litigation. For lenders, a simple loan can turn into a devastating learning experience without the proper knowledge and planning. An ounce of prevention can be worth a pound of cure when it comes to deciding on an appropriate interest rate on your loan or note.
If you need a promissory note or loan document reviewed, negotiated and/or drafted, call the trusted business attorneys at Gehres Law Group for help. With more than 80 years of collective experience, we work diligently to ensure our clients’ interests always come first, whether addressing usury laws or a wide range of other business-related legal issues. Contact us today for your free evaluation.
© 2017 Gehres Law Group, P.C. This article is for general information only. The information presented should not be construed to constitute formal legal advice nor the formation of a lawyer/client relationship.