Baker, Donelson, Bearman, Caldwell & Berkowitz shareholder Ken Weinberg and of counsel Jennifer Howard remind equipment lessors that a usury savings clause is not a “get out of jail free card.”
Lessors and lenders engaged in equipment leasing and finance should remember that a usury savings clause is not a “get out of jail free card.” Historically, equipment lessors have been less concerned with usury issues than their straight-loan brethren. The rationale is that the rent charged to lessees constitutes compensation for the use of the equipment, rather than interest paid for money borrowed. It is important to remember, however, that dollar-out leases or other leases intended as security may be viewed as the functional equivalent of a loan for a variety of legal purposes. Of course, equipment finance agreements or other documentation clearly designated as a loan should always be viewed as providing for payments of principal and interest.
Usury laws can limit the maximum allowable rate of interest that may be charged on a loan. These laws are complex and vary by state. For example, some usury laws exempt commercial loans that exceed a certain dollar amount, and even among those states, the law varies as to what constitutes a “commercial loan.”
Usury savings clauses are quite common and generally provide that if the rate of interest charged exceeds the maximum rate of interest permitted under the law, any excess amounts paid by the borrower would be deemed payments of principal or, if the loan were fully repaid, refunded to the borrower. Some lenders place such clauses in their loan documents as a form of “insurance,” hoping that such clauses would allow the loan to be enforced in case of an inadvertent violation of usury laws.
However, lenders should be aware that not all states will enforce usury savings clauses, as is illustrated by one recent case. In NV One, LLC v. Potomac Realty Capital, LLC, the Rhode Island Supreme Court, in a case of first impression, found that usury savings clauses are unenforceable, because they violate state public policy. In that case, two commercial entities entered into loan documents which contained detailed usury savings provisions. Because the loan documents required certain amounts to be held in reserve accounts, less money was actually disbursed to the borrower than the total contemplated amount of the loan. The lender charged interest on the entire face amount of the loan, including the amount held in reserves, even though the reserves were never funded into any reserve account and, instead, were reflected solely as journal entries in the lender’s books.
The trial court found that if interest was calculated based on the loan proceeds actually disbursed, the rate exceeded the maximum allowable rate. The lender did not challenge this finding in its appeal, but instead argued that the usury savings clause should be enforced.
After considering the plain language of the statute and previous cases interpreting it, the Rhode Island Supreme Court found that the public policy of the state was to place the onus on the lender to ensure compliance with the usury laws. The Court opined that enforcing usury savings clauses would undermine this policy by allowing lenders to attempt to charge usurious interest and, at worst, invoke the savings clause to avoid any penalty. The result of enforcing such clauses, the Court reasoned, would be to place the burden of ensuring compliance on the shoulders of the borrower, in contrast to the statute’s policy of placing the burden of compliance on the lender. Accordingly, the Court refused to enforce the usury savings clause and voided the usurious loan documents.
The Court rejected the argument that the status of both parties as sophisticated business entities should affect the result. Although the law contained a special exception for commercial loans that exceed one million dollars, the loan in this case did not qualify for the exception because the lender did not comply with certain statutory requirements needed to avail themselves of this exception.
Certain other states have also refused to enforce usury savings clauses based on an analysis of that state’s public policy. Before relying on a usury savings clause, lenders should know whether such clauses are enforceable in the particular states where the lender does business. Lenders should also pay attention to fees paid by the borrower in connection with the loan, as certain fees can be considered a part of the interest paid on the loan. Penalties for violating usury statutes can include forfeiture of the principal and/or interest, treble damages calculated based on the amount of interest paid by borrower, and even criminal penalties in certain cases.