Unconscionability and Usury: Where Do You Draw the Line?

February 25, 2020 by Melissa C. Martorella, Esq.

The term usury refers to the act of charging an interest rate over the statutorily mandated minimum. California law restricts non-exempt lenders to charging the greater of ten percent annual percentage rate, or five percent plus the Federal Reserve Bank of San Francisco’s discount rate on money used for personal or household purposes.

Usury laws have long played an integral part in affirmative defense of disputing a contract, but even loans that are exempt from usury laws may still be litigious under California unconscionability statutes.

In 2018, the California Supreme Court ruled that the interest rate on consumer loans greater than $2,500 may be considered “unconscionable” under the California Financial Code. In the case of De La Torre v. CashCall Inc., the court ruled that although the loan may not be considered usurious under California law, that the financial terms for an unsecured loan above $2,500 with an interest rate above 135% does fall under the unconscionability clause of California finance law.

Certain contracts are scrutinized for unconscionability when there may be an appearance that a party was at a disadvantage when signing the contract, or if the party had little to no ability of negotiating a fair contract.

Courts have been open to considering a loan as unconscionable if the terms are so unfair, that it would be wrong to uphold them. Cases of severe unfairness, lopsided bargaining power, and lack of proper notice are some examples of contracts that “shock the conscience,” in the eyes of the court, and could be grounds for unconscionability.

As a general rule, courts do not typically free a party from the obligations under a contract merely because they did not read or understand the terms of the arrangement. However, there are some unfair terms that could lead a court to determine that the contract is unconscionable. They may include:

  • Damage limitations against one party
  • Imposition of punitive penalties or fees on one party
  • Limitations on a party’s right to seek court relief against the other party
  • Open-ended provisions that favor one party with unilateral discretion to set pricing or fix other terms

The California Supreme Court rulings indicate that they are not so much critical of a bad deal, but rather that the idea of unconscionability stems more from the party in power forcing unreasonable terms on the other, which is typically, the consumer or borrower under a loan. The courts have made it clear that they will not enforce contracts that are “overly harsh” or that are so “oppressive” that they shock the conscience, regardless if they do not fall under the legal definition of usury due to an exemption.

For private lenders, this means that just because you can legally charge a certain interest rate does not mean you should do so. A court could look at the terms of your loan and determine that the interest rate, prepayment penalty, or other terms were so one-sided or unfair to your borrower as to render the contract unconscionable. Even on business purpose loans, unconscionability can be argued as a defense, so lenders should be wary of interest rates or default rates or other loan terms that are much higher or out of line with what the market is asking.

Although both parties to a contract can admit that a contract exists, one party may still argue a valid defense of unconscionability based on what they consider highly unreasonable terms or other one-sided consequences of the agreement.

Under California Contract Law, and in light of the California Supreme Court decision, one party can argue unconscionability if they make the case that the contract is so unfair that the court should not enforce it. While the judge has the ultimate authority in determining if a contract is so unreasonable that it rises to the level of unconscionability, if a consumer can put up a strong affirmative defense, proving that extreme circumstances make the contract unduly oppressive, they have a good chance of making their unconscionability claim stick.

Have questions about usury or whether the interest rate on your loan may be considered unconscionable? Contact Geraci LLP here.

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