Clause Without Effect: Unenforceable Usury Savings Clauses, 1214 RIBJ, 63 RI Bar J., No. 3, Pg. 5

• Author: Jenna Wims Hashway, Esq. Law Clerk at the U.S. Court of Appeals for the First Circuit.

Clause Without Effect: Unenforceable Usury Savings Clauses

Vol. 63 No. 3 Pg. 5

Rhode Island Bar Journal

December, 2014

\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0November, 2014

\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0 Jenna Wims Hashway, Esq. Law Clerk at the U.S. Court of Appeals for the First Circuit.

\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0Usury is an antediluvian concept, sounding “in an ancient moral tradition, skeptical of the advisability of high-cost loans to those with limited means.”^[1]But, while it may be old, in Rhode Island, it’s still news. During its most recent term, the Rhode Island Supreme Court issued two opinions that will change the way contracts are drafted and loans are made. The cases of NV One, LLC v. Potomac Realty Capital, LLC, 84 A.3d 800 (R.I. 2014) and LaBonte v. New England Development R.I., LLC, 2014 WL 2802772 (R.I. 2014), while factually quite different, both involve the question of whether a usury savings clause is enforceable under Rhode Island’s usury statute.

\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0“A ‘usury savings clause’ is a provision in a loan agreement that attempts to negate any other provisions in the agreement that might result in the extraction of an illegal rate of interest.”^[2]These clauses generally seek to conform the agreement to the local usury laws, either by lowering the interest rate to the maximum rate permitted by law, or by applying payments made in excess of that rate to reduce the principal balance of the loan.

\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0The question of whether these clauses will be given effect is a crucial one, because Rhode Island’s usury statute imposes a drastic remedy. “Every contract made in violation of any of the provisions of § 6-26-2 [the usury statute], and every mortgage, pledge, deposit, or assignment made or given as security for the performance of the contract, shall be usurious and void.”³ Further, “the borrower shall be entitled to recover from the lender the amount so paid in an action on the case.”⁴ In other words, if a loan contract is held to be usurious, the contract is void and the borrower is entitled to recover not only the excess interest payments, but the entire amount he or she has paid on the loan, and, because the contract is void, the lender cannot even recover the principal.

\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0Although long enshrined in Rhode Island law, little attention had been focused on this remedy until the Rhode Island Supreme Court heard the appeal of NV One, LLC v. Potomac Realty Capital, LLC, a case of first impression. In NV One, the plaintiff entered into a loan agreement with Potomac to secure financing to renovate a former post office.⁵ NV One signed a promissory note for the principal amount of $1,800,000 and granted a mortgage to Potomac, as well as an assignment of leases and rents.⁶ The note set the interest rate at “the greater of 5.3% or the LIBOR Rate, plus 4.7%.”⁷ The note also set a “default rate” at the lesser of 24% percent or the maximum rate allowable under applicable law⁸ After including fees associated with the loan, the total value of the loan was $1,815,000.^[9] However, the entire principal balance was never fully disbursed.^[10]

\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0In August 2008, the plaintiff invoked a provision in the loan agreement allowing it to extend the maturity date of the loan for another ten months, until June 2009.¹¹ Prior to August 2008, Potomac charged interest at 10%, however, it charged the interest on the total $1.8 million dollars, despite not having disbursed the full amount to the plaintiff.¹² After the loan was extended, Potomac charged interest at a rate of 12%—again on the total amount of $1.8 mil-lion.¹³ It was later determined that the highest amount ultimately disbursed was only $1,007,390.52.”¹⁴

\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0In February 2009, Potomac sent a thirty-day notice of default to plaintiff, and when the default was not cured by March, Potomac began charging the 24% default rate against the entire $1.8 million.¹⁵ In November 2009, Potomac sent a notice of foreclosure to NV One and demanded payment from the plaintiff’s principals, pursuant to their personal guarantees.¹⁶ Plaintiff NV One filed suit against Potomac, alleging fraud, breach of contract and usury.¹⁷ Subsequently the plaintiff moved for summary judgment on its usury claim.¹⁸

\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0The defendant sought to invoke a savings clause in the loan agreement that stated:

A. It is the intention of Maker [NV One] and Payee [PRC] to conform strictly to the usury and similar laws relating to interest from time to time in force, and all agreements between Maker and Payee, whether now existing or hereafter arising and whether oral or written, are hereby expressly limited so that in no contingency or event whatsoever, whether by acceleration of maturity hereof or otherwise, shall the amount paid or agreed to be paid in the aggregate to Payee as interest hereunder or under the other Loan Documents or in any other security agreement given to secure the Loan Amount, or in any other document evidencing, securing or pertaining to the Loan Amount, exceed the maximum amount permissible under applicable usury or such other laws (the “Maximum Amount”).

B. If under any circumstances Payee shall ever receive an amount that would exceed the Maximum Amount, such amount shall be deemed a payment in reduction of the Loan owing hereunder and any obligation of Maker in favor of Payee * * * or if such excessive interest exceeds the unpaid balance of the Loan and any other obligation of Maker in favor of Payee, the excess shall be deemed to have been a payment made by mistake and shall be refunded to Maker.¹⁹

\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0In ruling on the plaintiff’s motion, the hearing justice first held that the loan was void as usurious because “the value for computing the maximum permissible interest is not the amount on the face of the loan, but, rather, the actual amount received by the borrower.”²⁰ Although the rate charged varied from 10% to 12% to 24% during the course of the loan, because those rates were applied to the entire loan amount rather than the amount actually disbursed, the hearing justice found that “[t]here can be no doubt that these interest amounts charged exceeded twenty-one percent,” the maximum allowable rate under the Rhode Island usury statute.²¹

\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0The defendant appealed and did not contest the lower court’s factual findings. Instead, Potomac argued that the hearing justice erred by declaring the usury savings clause unenforceable.²² Potomac contended that usury savings clauses should be enforceable under Rhode Island law.²³

\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0\xA0On appeal, the Rhode Island Supreme Court first affirmed the lower court’s holding that the loan was usurious, noting that, not only was the default interest rate (24%) usurious on its face, but, regarding the lower interest rates imposed, “[t]he fact that PRC calculated the interest amount against the face amount of the loan as opposed to the amount of the disbursed funds is of critical importance to the usury determination.”²⁴ The Court calculated that in August 2007 when the facially benign rate of 10.25% was charged against the total loan amount, rather than the considerably lower amount actually disbursed, an effective rate of interest of 23.17% resulted.²⁵ Further, the Court found that the default rate, “when calculated against the actual...