11.7 Lending Agreements

• Library: Contract Law in Virginia (Virginia CLE) (2019 Ed.)

11.7 LENDING AGREEMENTS

11.701 Introduction.

A. General Principles Applicable. The legal principles governing contracts are also generally applicable to lending agreements. There are,

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however, specific principles that are relevant to the notes, guarantees, and security documents that may be involved in a loan transaction. ¹²⁹²

B. Consumer Credit Requirements Not Addressed. The following discussion is not intended to cover the statutes, regulations, and other legal principles applicable to credit transactions with individuals for personal, family, or household purposes. There are numerous state and federal laws applicable to those transactions that limit or abrogate the enforceability of provisions that are otherwise acceptable in a commercial context. For example, applicable federal rules prohibit confession of judgment provisions in those transactions. Other resources should be consulted for drafting requirements in consumer credit transactions.

11.702 Interest and Usury.

A. Legal Rate. The current legal rate of interest in Virginia is six percent per annum. ¹²⁹³ Except as otherwise provided in the sections of the Virginia Code relating to judgment interest ¹²⁹⁴ and negotiable instruments, ¹²⁹⁵ this legal rate is implied where there is an obligation to pay interest but there is no contract to pay interest at a specified rate. Virginia law has long recognized this implied contract to pay interest because a person who has the use of another's money should pay for its use. ¹²⁹⁶

In the absence of an agreement to the contrary, interest is payable from the time money is received until it is repaid. ¹²⁹⁷ If the note does not specify a date for payment, it is due and payable on the day of its date and bears interest from that date. ¹²⁹⁸

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If partial payment is made on a debt, it will be applied first to interest and then to principal unless the debtor directed otherwise at the time of payment. ¹²⁹⁹

In general, interest is not allowed on interest. ¹³⁰⁰ This general rule may, however, be modified by the agreement of the parties. An agreement by a debtor to pay interest on interest already accrued in consideration of his or her creditor's forbearance will be enforced. ¹³⁰¹

B. Judgment Rate. In Virginia, the judgment rate of interest is currently six percent, but a judgment entered in an action brought on a contract bears interest at the rate lawfully charged on the contract or six percent per annum, whichever is higher. ¹³⁰² If no rate is specified in a negotiable instrument, interest at the judgment rate applies to both prejudgment and postjudgment interest. ¹³⁰³ The court also has discretion to award prejudgment interest at the judgment rate in a suit for breach of contract where no interest rate is specified in the contract. ¹³⁰⁴

C. Contract Rate. Section 6.2-303 of the Virginia Code sets forth Virginia's contract rate of interest and provides that "[e]xcept as otherwise permitted by law, no contract shall be made for the payment of interest on a loan at a rate that exceeds 12 percent per year." ¹³⁰⁵ The emphasized language is really the key to Virginia's usury law because the exceptions are so extensive that, as a practical matter, usury is rarely an issue in lending contracts. If the defense of usury is not available in a particular case, interest and other charges may be imposed as agreed by the parties, and loan fees and other charges, which are in addition to the stated interest rate, need not be included in the stated interest rate. ¹³⁰⁶

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D. Penalty for Usury.

1. In General. A defendant borrower may plead that the contract sued upon was for interest greater than allowed by statute. If the court finds the contract usurious, judgment will be rendered only for the principal amount due. ¹³⁰⁷ A usurious contract is not void but is deemed to be for an illegal consideration as to any amount beyond the principal. ¹³⁰⁸ If a loan is usurious, the borrower's failure to pay interest does not constitute a default that will entitle the lender to realize its collateral for the loan. ¹³⁰⁹

2. Personal Nature of the Usury Defense. The defense of usury is personal to the borrower and not for the benefit of third parties who are not in privity with the debtor. ¹³¹⁰ The holder of a junior mortgage may not attack the prior mortgage as usurious, ¹³¹¹ and a purchaser of property who buys the property subject to a usurious lien that he or she assumes cannot avoid payment. ¹³¹²

3. Recovery of Interest. A person who has paid usurious interest may recover from his or her creditor the total amount of interest paid in excess of the amount allowed by law, twice the amount of interest paid during the two years before the suit was filed, and court costs and reasonable attorney fees, provided that suit is brought within two years from the earlier of the date of the last scheduled payment or the date of payment in full. ¹³¹³

E. Waivers Void. A contract in which a borrower waives or releases any benefits or rights to which he or she is entitled under chapter 3 of title 6.2 of the Virginia Code is void as against public policy, unless the waiver or release is made after a loan as part of a settlement of claims. ¹³¹⁴

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F. Exceptions. There are numerous exceptions to the allowable contract rate of interest.

1. Installment Loans. A bank or savings institution making an installment loan, including an affiliate of a bank or savings institution making a motor vehicle loan, may impose finance charges and other charges and fees at such rates and in such amounts and manner as may be agreed by the borrower. ¹³¹⁵

2. Educational Loans. A loan made by a bank or savings institution for educational expenses may be enforced as agreed in the contract of indebtedness. ¹³¹⁶

3. Loans of at Least $5,000. The defense of usury is not available to avoid the payment of interest or any other sum on a loan made by a bank, savings institution, industrial loan association, or credit union if the original principal amount is $5,000 or more. ¹³¹⁷

4. Demand and One-Year Loans. A loan made by a bank, savings institution, or licensed stockbroker or broker dealing in options and futures payable on demand or within a year may be enforced as agreed in the contract of indebtedness. ¹³¹⁸

5. Open-End Credit. A bank or savings institution may impose finance charges and other charges and fees at such rates and in such amounts and manner as a borrower may agree in a contract for open-end credit (also commonly referred to as revolving credit). However, if the extension of credit is effected by means of a credit card for merchandise or services, no finance charge may be imposed if payment in full of the unpaid balance is received by the creditor by the due date, which must be at least 25 days after the billing date. ¹³¹⁹

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6. Other Exceptions. The Virginia Code provides special exceptions for charges by credit unions, ¹³²⁰ extensions of credit by broker-dealers registered with the Securities and Exchange Commission, ¹³²¹ charges by private colleges and universities, ¹³²² loans by pension plans to participants, ¹³²³ and charges by industrial loan associations. ¹³²⁴

7. Commercial Loans. Perhaps the broadest and most widely used exceptions are those for commercial transactions. The defense of usury is not available to avoid the payment of interest or any other sum in connection with a loan of $5,000 or more for business or investment purposes, regardless of who the lender is. ¹³²⁵ The defense of usury is not available to a corporation, partnership, limited liability company, business trust. real estate investment trust, or real estate joint venture. ¹³²⁶

G. Late Charges. Section 6.2-400 of the Virginia Code provides that any lender or seller may impose a late charge for failure to make payment within seven calendar days after the due date of any installment due on a debt, whether installment or single maturity, if the late charge does not exceed five percent of the amount of the installment and the late charge is specified in the lending contract. A provision for late charges in excess of the amount permitted is void as to the excess but does not otherwise affect the validity of the agreement. ¹³²⁷ In Perez v. Capital One Bank, ¹³²⁸ the court considered the relationships among former sections 6.1-330.80 and 6.1-330.63 of the Virginia Code and the common-law doctrine of unlawful liquidated damages. ¹³²⁹ The plaintiff alleged that the late fees charged by her credit card bank constituted unlawful liquidated damages (penalties) under the common law and that section 6.1-330.63 does not preclude her from making this claim

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because it does not contain language clearly manifesting an intent to abrogate the common law. The court held that the General Assembly intended to abrogate the common law prohibiting a penalty when it enacted section 6.1330.80 and that in enacting section 6.1-330.63 it removed the five-percent cap on late charges with respect to charges made by banks and savings institutions on revolving credit contracts. Therefore, any lender or seller may charge a five-percent late fee, and where the Virginia Code so provides, certain lenders may charge late fees as agreed in the contract of indebtedness.

H. Prepayment and Acceleration. Prepayment fees and acceleration clauses in lending contracts are generally enforceable as agreed between the parties, although there are specific limitations in real estate and consumer transactions.

I. Rule of 78. Upon prepayment of a loan, a borrower may be entitled to a rebate of unearned interest, which in some instances may be determined by using the Rule of 78, calculated in accordance with section 6.2-403 of the Virginia Code. The rule is so called because the months of one year—one through twelve—added together equal 78. ¹³³⁰ The rebate is calculated by multiplying the amount of interest that would have been paid over the life of the loan by a fraction. ¹...