The following is a case update written by the Hon. Meredith Jury (U.S. Bankruptcy Judge, C.D. CA., Ret.), analyzing a recent decision of interest:
In a published opinion with a detailed description of the development and importance of California’s usury law, the California Court of Appeal (the Court) reversed a trial court ruling which reflected the lower court’s erroneous understanding that California’s complicated relationship with usury, with many exceptions, demonstrates that the prohibition of usury is a fundamental public policy of the state. As the Court stated: “The complexity of the law does not imply a lack of commitment to the policy.” G Companies Management, LLC v. LREP Arizona LLC, 88 Cal. App. 5th 342, 304 Cal. Rptr. 3d 651 (2023).
To view the opinion, click here.
G Companies, a California limited liability company, approached LREP, a Texas limited liability company which conducts business in Arizona, for a $4 million short-term loan. A loan with a six month term and a 36 percent interest rate (with an additional 10 percent in the event of default) was consummated in October 2015. The loan was secured by real property in San Juan Capistrano, California, (the “Property”) and guaranteed by two individuals (the “Guarantors “). The agreement provided that LREP’s remedy for a default was limited to foreclosing on the Property and suing the Guarantors. The agreement specified the use of an escrow agent in Arizona for the closing and had a forum selection clause for Maricopa County, Arizona.
G Companies defaulted when the first payment was due and LREP foreclosed on the Property, establishing a $4.6 million deficiency. When LREP threatened to sue the Guarantors in Arizona, they entered into a forbearance agreement which would result in entry of judgment for the deficiency if they defaulted. They defaulted and the judgment was entered. The Guarantors then sued G Companies in California for indemnification, which caused G Companies to file a cross complaint against LREP for equitable remedies all arising from LREP’s alleged collection of usurious interest against the Guarantors, which violated the implied covenant of good faith and fair dealing in the loan agreement.
LREP moved to stay the cross complaint based on the forum selection clause’s designation of Arizona. G Companies opposed the stay, arguing that enforcement of the clause would deny a California resident the protection of California’s fundamental public policy regarding usury, which would not be available in Arizona. The trial court stayed the cross complaint, concluding that “California’s usury law is too riddled with exceptions to reflect any significant public policy about interest rate limitations,” citing a 1964 case which implied that the usury law does not reflect a strong public policy because of the numerous exceptions and exemptions.
The stay order was deemed final and appealable under California procedures, so G Companies appealed to the Court which reversed, holding that California did have a fundamental public policy against usury which was not waivable.
The Court first cited the well-accepted principle that California law prohibits enforcement of a forum selection clause if the result would deny a California resident the benefits of a fundamental public policy, relying on America Online, Inc. v. Superior Court (2001) 90 Cal. App. 4th 1, 12. which held “California courts will refuse to defer to the selected forum if to do so would substantially diminish the rights of California residents in a way that violates our state’s public policy.” It then proceeded to reject the trial court’s premise that prior caselaw established that enforcement of the state’s usury policy was not a fundamental public policy.
The Court began that analysis by noting that usury was not just a statutory provision in the California codes, but rather was addressed in the California Constitution, article XV, section 1, which sets interest rates, with exceptions. That standard was founded upon an initiative measure in 1918, then incorporated into the Constitution, and later codified for enforcement in California Civil Code section 1916 which, among other things, makes any agreement or contract requiring interest in excess of the Constitutional rates null and void. It did acknowledge that the law was complex by allowing different interest rates to be charged in different circumstances and providing exemptions for certain types of loans or lenders. However, this complexity was more an indication of the importance of usury laws; it did not imply that usury was not taken seriously. In fact, prior caselaw has established that the protections of the usury law cannot be waived, since a usurious provision is void. WEI Opportunity Loans II, LLC v. Cooper (2007) 154 Cal. App. 4th 525, 542-43. Any public policy that cannot be waived qualifies as fundamental. Brack v. Omni Loan Co., Ltd. (2008) 164 Cal. App. 4th 1312, 1323.
Relying on this analysis, the Court then rejected LREP and the lower court’s interpretation of prior caselaw to imply enforcement of the usury law was not a fundamental public policy. With that standard established, the Court then concluded the burden fell on LREP to show enforcing the forum selection of Arizona would not diminish any substantive rights afforded under California laws. Because it had not done so, the trial court’s decision to stay the cross complaint was error and the Court reversed that ruling.
The significance of this case extends far beyond the borders of California because it speaks to the ability of parties to an agreement, anywhere in the country involving a California resident, to include a forum selection clause in that agreement. It is common for many national lenders or creditors to include such clauses in both business and consumer contracts, often selecting a forum other than California, with its reputed consumer bias in legislation and policy and a perception that the state is not friendly to businesses. This opinion makes clear that California courts will not enforce such forum selection if they believe doing so would impinge on fundamental rights of its citizens.
The usury example of such non-enforcement is particularly significant because of the perception that caused the trial court to rule incorrectly. It is true that California’s usury law has so many exceptions and exemptions that it is common for parties, lawyers and even courts to believe that almost no transaction can be challenged as usurious. The Court of Appeal reminds us that impression is an incorrect one. At the conclusion of its analysis, the Court states: “A policy’s complexity does not suggest to us that policy is insignificant; in fact, the attention to detail implies just the opposite.”
The practice tip when drafting an agreement which imposes interest is to become thoroughly familiar with the nuances of California usury law and draft in compliance with that law. Otherwise, pre-default interest is null and void.
This review was written by the Hon. Meredith Jury (U.S. Bankruptcy Judge, C.D. CA., Ret.), a member of the ad hoc group. Thomson Reuters holds the copyright to these materials and has permitted the Insolvency Law Committee to reprint them. This material may not be further transmitted without the consent of Thomson Reuters.