When a lender makes a loan that does not comply with usury laws it runs a risk that not only will interest and charges be disallowed, but also the entire loan may be declared void. In cases where declaring a usurious loan void is discretionary, one might expect a bankruptcy court to be inclined to do so since it could benefit the bankruptcy estate.
In Loucheschi the court was asked to estimate a construction lender’s claim for purposes of determining its rights in connection with confirmation of a proposed plan of reorganization. LBM Financial LLC (LBM) made a $3.9 million construction loan in 2006 that had a contract rate of 16% per annum and a default rate of 20% per annum plus 1% per month plus a 10% late charge for each overdue payment. Default charges at this rate were determined to be the equivalent of 41% per annum in another case, and as this court notes, are clearly in excess of 32% per annum. LBM filed a proof of claim in the bankruptcy case for approximately $5.6 million.
A little over half of the 2006 construction loan was used to repay a 2004 acquisition loan made by LBM to the borrower, which in turn was used to repay an LBM loan to the prior owner of the property. The court remarked that it expected that LBM collected fees and interest at each stage in this process. Referring to LBM as a “hard money lender,” the court noted that LBM had earned approximately $640,000 on the 2004 loan of $1.9 Million in just under 2 years.
The Massachusetts criminal usury statute caps interest and expenses, including default charges, at 20%. Under the statute a lender may exceed the cap if it registers with the attorney general. Although there was testimony that LBM believed it was registered, it did not produce any evidence of registration.
On advice of counsel, the proof of claim filed by LBM recalculated the loan balance by retroactively using simple interest at 8% per annum in place of the 16% compounded interest that it had been charging and was provided for in the loan documents. However, the statute makes it usurious to contract for interest and expenses in excess of the cap. So, LBM could not avoid usury by not actually charging a usurious rate.
Not surprisingly, the court concluded that the loan was usurious under the Massachusetts criminal usury statute. Although the law permits a usurious loan to be declared void, Massachusetts courts have found that this is not mandatory, and a court may “fashion an equitable remedy based on a specific facts of the case.”
In evaluating the appropriate remedy, the court began by observing that “one of the striking and most troubling features about LBM’s method of doing business is the lack of predictability or consistency in the way it administers its loans.” For example, it did not require regular payments on its loans. Only three interest payments were made on the 2004 acquisition loan and no payment was ever made on the 2006 construction loan. The borrower could not get LBM to issue a payoff letter when it was trying to refinance, and the interest rate on the construction loan was “apparently whatever [LBM’s owner] said it was.”
Based on this rather negative picture of LBM, one might have anticipated that the court would void the loan. Surprisingly, that was not the case. Instead the court concluded that the equitable remedy was to simply disallow the interest portion of the 2006 loan – even while noting that the principal amount of the 2006 loan itself included interest since the payoff of the 2004 loan included over $450,000 in interest and charges.
Reading between the lines, it appears that the court may have been equally disenchanted with the borrower. The court made a comment that the borrower’s testimony “did not withstand cross-examination,” giving as an example testimony that disbursements were not authorized that was rebutted by the production of signed directives. Similarly, the court commented that the borrower’s testimony that it relied on representations regarding the project “strains credulity. Only a person who signs legal documents without reading them, as [a principal of the borrower] testified he did, could be naïve enough to assume he could expose himself to millions of dollars of potential liability without taking steps to independently verify such easily verifiable but critically important statements.”
The court offers no insights into the equities that caused it to allow a claim for a loan that clearly violated the applicable criminal usury statute instead of declaring the loan void, as was permitted by the statute. This case stands in stark contrast to cases such as Rhiel v. Central Mortgage Co. (In re Kebe), 469 B.R. 778 (Bankr. S.D. Ohio 2012), where a mortgage lien was avoided and the lender faced the possibility that it might be required to pay the value of the lien to the bankruptcy estate sometime in the future, all because the notary failed to fill in the blank identifying the person signing the mortgage. Perhaps the lesson to be learned from this case is that it is always worth making an argument because you might win?