In an issue of first impression, Rhode Island Supreme Court holds that usury savings clauses in loan contracts are unenforceable and cannot validate an otherwise usurious loan. NV One, LLC v. Potomac Realty Capital, LLC, 84 A.3d 800 (Feb. 18, 2014)
In 2007, NV One, LLC (“Borrower”) and Potomac Realty Capital, LLC (“Lender”) entered into a commercial loan agreement for loans up to an aggregate principal amount of $1.8 million. The agreement included a usury savings clause that sought to cap any interest charges to the maximum allowed under law. Throughout the term of the loan, the Lender never disbursed the full $1.8 million but it always charged interest on the $1.8 million commitment rather than the actual amount disbursed. In 2009, the Borrower defaulted on the loan and the Lender sought to exercise its remedies.
The Borrower sued the Lender claiming among others, usury, and seeking to enjoin the Lender from exercising its remedies under the loan agreement. The Borrower moved for partial summary judgment on the usury claim. The trial justice granted the Borrower’s motion because he found the loan to be usurious and held the usury savings clause unenforceable and incapable of rehabilitating the otherwise usurious loan. The Lender appealed.
The Supreme Court first affirmed the finding that the loan was usurious. Rhode Island’s statutory maximum rate is 21%, and under Rhode Island law, the maximum allowable interest is calculated based on the amount actually received by the borrower, not the commitment. For example in a period in 2007, the Lender only disbursed $797,500 but charged the Borrower 10.125% interest on the full $1.8 million commitment, which if calculated on the actual amount disbursed, resulted in an actual interest rate of 23.17%. The same happened with default interest charge in 2009. Therefore, the court affirmed the trial court’s finding that the loan was usurious.
The court next considered the first impression issue of whether the usury savings clause was effective to save the usurious loan. It remarked that contract terms are unenforceable if they violate public policy. Examining the public policy behind usury laws (which is to protect borrowers from usurious loans), it noted that the Rhode Island legislature established a hardline approach against usurious interest rates that amounted to strict liability, and that lenders bore the onus of avoiding usury. It cited its own precedent and other cases, which all placed the burden of compliance on lenders.
The court determined that enforcing the usury savings clause would frustrate the public policy of the usury laws. It reasoned that enforcing the clause would give lenders perverse incentives to charge usurious rates and rely on the clause to save them from liability. It also noted that enforcing the clause would shift the burden of compliance with usury laws from the lender to the borrower. Finally, it rejected the Lender’s argument that the clause should be enforced because the parties were sophisticated entities by pointing out the specific statutory exception from the usury laws for loans to commercial business entities and noted that the Lender could have, but did not, comply with the requirements for the exception.
Therefore, the Supreme Court held that usury savings clauses in loan contracts are unenforceable as violating the public policy of Rhode Island’s usury laws, and upheld the trial court’s decision that the loans made by the Lender were usurious and therefore void.
Both creditors successfully acquired security interests in the promissory notes and mortgages. One of the creditors, MKA, recorded its security interest in the mortgages on April 18, 2008 and June 5, 2008. But MKA did not perfect its security interest in the promissory notes until it filed a UCC financing statement on June 2, 2009. The second creditor, the Hendricksons, recorded their security interest in the mortgages after MKA on October 23, 2008. However, the Hendricksons filed a UCC financing statement on October 23, 2008, took possession of the promissory notes through an escrow agent on November 6, 2008, and took physical possession of the promissory notes on January 5, 2009 after the debtor’s default. Each of these actions by the Hendricksons was sufficient to perfect their security interest in the promissory notes, each of which occurred prior to MKA filing its financing statement on June 2, 2009.
The bankruptcy court held that the security interests in the promissory notes fell under the purview of Article 9 because promissory notes are personal property. Because the mortgages followed the promissory notes under Washington state law, the security interests in the mortgages were perfected when, and only when, the security interests in the promissory notes were perfected.
Though MKA recorded its security interest in the mortgages earlier than the Hendricksons, it perfected its security interest in the promissory notes after the Hendricksons had perfected their security interest in the notes. MKA would have been successful under the state recording statute, but it did not have priority under Article 9 of the UCC. Thus, the court rejected MKA’s claim and granted summary judgment to the Hendricksons because they were the first to perfect a security interest in the promissory notes.