Business Law

In re Moon (Bankr. N.D. Cal.)

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The following is a case update written by Dean T. Kirby, Jr. a member of the firm of Kirby & McGuinn, A P.C., analyzing a recent decision of interest:


Bankruptcy Judge Montali applied California law to find that a “settlement agreement” extending the term of a business purpose mortgage loan was usurious, and that a late charge, applied to a balloon payment was unenforceable as liquidated damages.


In June, 2015, Mark and Lori Moon borrowed $759,000 for business purposes from Milestone Financial, LLC, secured by their residence. The Moons were represented by a California licensed real estate broker. Milestone did not have a real estate broker’s license and was not licensed as a mortgage loan originator under the California Finance Law or the California Residential Mortgage Lending Act. Two months earlier, the California Department of Real Estate had issued a cease and desist order forbidding Milestone from making mortgage loans until the appropriate licenses were obtained.

The loan required monthly payments of interest only at 11.3% per annum and was all due and payable in two years. The promissory note (“Note”) provided for a 10% late charge on delinquent monthly payments and a default interest rate of 17.3% plus late fees. Both provisions were supported by language reciting that these were reasonable liquidated damages. The Note included a savings clause that limited the interest charged to the applicable legal rate (10%) in the event that a court found that the interest charged was “in excess of applicable law.”

The Moons struggled with payments during the first year, and Milestone advanced taxes and insurance. In August, 2016, Milestone and the Moons entered into an agreement titled “Settlement Agreement, Indemnity, and First Amendment to Promissory Note Secured by Deed of Trust” (the “Extension”).

The Extension moved back the loan maturity date for an additional two years and provided for a slightly reduced interest rate of 11.05%. It recited that the new principal balance was $902,525.34. It increased the default interest rate and added language which applied the late charge to “any payment then due, including the final (balloon) payment.” These provisions were again supported by language reciting that these charges were reasonable liquidated damages.

In March 2019, the Moons sought to refinance the loan and requested a payoff demand from Milestone. The demand was for $1.288.792.28, and included a “prepayment penalty” of $115,615.06 which Milestone later referred to in the litigation as a late charge on the balloon payment. The Moons were unable to refinance.

In November, 2019, the Moons sued Milestone in San Mateo County Superior Court alleging causes of action for (i) declaratory relief; (ii) breach of contract: (iii) fraud; and (iv) interference with contract in relation to the refinance. While the lawsuit was pending, Milestone commenced a nonjudicial foreclosure. The superior court issued a TRO but denied a preliminary injunction. The Moons filed a Chapter 13 petition, and the case was later converted to Chapter 11. The lawsuit was removed to the Bankruptcy Court, and after an unsuccessful mediation, both sides moved for summary judgment. The Moons presented unpleaded claims in their motion, viz. that the loan was usurious, that the “prepayment penalty” was unenforceable, and that Milestone could not impose both a late charge and default interest.

The Court granted partial summary judgment to the Moons on their claim relating to usury and also sustained their challenge to the “prepayment penalty.” It refused summary judgment on the remaining claims for breach of contract, interference and the fraud claims, for the reason that these involved unresolved issues of fact.


The Court’s ruling on the usury issues involved the exacting application of California Civil Code section 1916.1, which exempts from the usury law a loan or forbearance arranged by a licensed real estate broker. The Court quoted its own decision in In re Arce Riverside, LLC, 538 B.R. 563, 571 (Bankr. N.D. Cal. 2015) in defining “forbearance” as “an agreement not to insist upon payment at the date of maturity of a debt, or the giving of further time to pay.”

Civil Code section 1916.1 provides that “[i]n order for a loan to be arranged by a broker, the broker must act “for compensation or in expectation of compensation for soliciting, negotiating, or arranging the loan for another . . .”However, the provision relating to forbearances is more limited in scope as it refers only to “a forbearance, extension, or refinancing of any loan secured by real property in connection with a past transaction in which the broker had acted for compensation or in expectation of compensation for selling, buying, leasing, exchanging, or negotiating the sale, purchase, lease, or exchange of real property or a business [italics added].” The Court held that this exemption did not apply to a forbearance involving a “simple loan of money secured by real estate, with no other sale, lease or other transaction involved. This court cannot create an exemption here to save Milestone.”

In ruling on the usury question, the Court did not discuss the above-quoted usury savings clause that was included in the Note.

The Court held that “the Extension supplemented and amended the Original Loan. It did not replace it.” Because the installment late charges were imposed based on provisions in the original loan, the Court held that these were enforceable. The Court characterized the “prepayment fee” as another late charge but disallowed it as unreasonable liquidated damages. The Court also held that California Civil Code section 2954.4, which applies to loans secured by owner occupied residential property and provides that late charges cannot be imposed “more than once,” was not applicable because subdivision 2954.4(e) says that section is not applicable to “loans made or negotiated by a real estate broker….” Since that applied to the original loan, the Court held that it still applied to the Extension.


In this case an unlicensed mortgage lender, subject to a cease and desist order issued by the California Department of Real Estate, made a loan secured by an owner occupied dwelling, which bore interest at 11.3% and included onerous default provisions. Then the lender allegedly prevented the borrowers’ effort to refinance that loan by presenting a payoff demand that included a $115,615.06 “prepayment penalty” that was unjustifiable as liquidated damages, and in any case wasn’t even provided for under the ambiguous late charge provision included in the Extension. When the refinancing did not go forward and the borrowers sued, Milestone then (incredibly!) commenced a foreclosure.

Tell that to most lawyers and they might wonder how the lender could expect to emerge from this scenario with any of its money back. Of course, Judge Montali’s limited ruling granting partial summary judgment is not the end of the story, as the borrowers still retain their claim for damages as the case now moves forward.

Mortgage loan brokers in California rely on the fact that loans made by their unlicensed investor clients and mortgage funds are exempt from the usury law because they are broker arranged. Most of them probably assume that an agreement to extend the term of an exempt loan would itself be exempt, especially when a real estate broker arranges the extension. Judge Montali cites to the plain language of Civil Code section 1916.1 to hold that broker arranged extensions are exempt only if the original mortgage obligation was incurred in “selling, buying, leasing, exchanging . . . real property or a business.” It is no exaggeration to say that this will be a shock to the private money lending industry.

Under this reading of the statute (which is hard to argue with), Judge Montali observes that “Milestone had the option to get licensed, lower the interest rate, or foreclose on the property, however unappealing and consequential that would have been to the Moons.” Under the holding in Moon, Milestone did not have the option of simply extending the loan term at the request of its struggling borrower (even without loan charges or an interest rate increase) without placing itself at substantial legal risk.

These materials were written by Dean T. Kirby, Jr. a member of the firm of Kirby & McGuinn, A P.C., located in San Diego, California. Mr. Kirby is a member of the ad hoc group and a member of the Commercial Transactions Committee of the Business Law Section. Editorial contributions were made by the Honorable Meredith Jury (United States Bankruptcy Judge, C.D. Cal, Ret.), also 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.

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