Rhode Island Supreme Court invalidates all security securing usurious notes, holding that all security cross-collateralizing notes is invalid if even one note is usurious. McGowan v. Potomac Realty Capital, LLC, 2014 R.I. Super. LEXIS 175 (Dec. 29, 2014).
Upon default, Commerce Park Realty, LLC (“Borrower“), through its receiver, sought declaration that promissory notes between Borrower and Potomac Realty Capital, LLC (“Lender“) violated Rhode Island’s usury laws and thus all security instruments, liens, and property interests securing the notes were void. The parties had consolidated the challenged notes, with a combined outstanding balance over $11,000,000 (the “Consolidated Notes“), at an interest rate of 16% (with a default rate of 24%) and secured them with mortgages over real property. The consolidated loans agreement stated, “[A]n Event of Default under any one of the Notes or Mortgages constitutes an Event of Default under all of the Notes and Mortgages,” and required an exit fee of $3,000,000 upon default.
The court noted, “[I]t is clear that the Legislature intended an inflexible, hardline approach to usury that is tantamount to strict liability,” and that “maximum allowable interest rate is a statutory construct whereby interest rates in excess of 21 percent per annum are deemed usurious” under R.I. Gen. Laws § 6-26-2. The court found the Consolidated Notes usurious in “several different ways.” The default interest rate of 24% was, on its face, in excess of the maximum allowed. Alternatively, the $3,000,000 exit fee raised the effective per annum rate on the Consolidated Notes to 52.39%, given that the “[e]xit [f]ee must be included in the interest rate calculations.” Even if the court applied the $3,000,000 exit fee pro rata to each note, the underlying interest rates all exceeded 21%. The court concluded, “It is without question that the underlying loans comprising the Consolidated Loans are usurious and thus violate § 6-26-2.”
The court further noted that “based on the cross-collateralization of the loans . . . all of the mortgages securing those loans must be avoided and discharged, even if only one of the loans is deemed usurious.” The Lender had argued that allowing the funds previously disbursed to the Borrower to remain un-repaid, and voiding all security interests securing the notes, would unjustly enrich the Borrower. In other words, the Lender would be unable to recover on a valid note already funded and matured. The court, unpersuaded, rigidly applied R.I. Gen. Laws § 6-26-4(a), which provides that “[e]very contract made in violation of any of the provisions of § 6-26-2 [by charging more than 21% interest], and every mortgage, pledge, deposit, or assignment made or given as security for the performance of the contract shall be usurious and void.” As such, the court discharged all of the corresponding security interests in the Consolidated Loans.
