Monday, November 26, 2007

Usury in Massachusetts

I ran across two articles on usury and expect we will see more as the debt markets and foreclosures continue to sort themselves out and more borrowers are faced with foreclosure.

Usury is the charging of excessive interest on a loan. Most states have a law prohibiting usury and defining what is meant by usury. Usury laws were originally targeted at loan sharks. As a result, most usury statutes make the charging of usurious interest a criminal act. They also generally allow the borrower to escape from making the excessive interest payments.

Massachusetts defines interest in excess of 20% to be the interest rate that triggers usury. M.G.L. Chapter 271, Section 49. The 20% threshold also includes any brokerage fees, recording fees, commissions, forbearance or any other amounts the borrower has to pay to the lender.

The 20% rate is prorated for shorter periods of time. Upfront fees can push an otherwise legal loan into a usury loan if it is maid off early. For example, if you have ten year loan at 18%, plus a 3% commission payable at closing, that loan is usurious if the borrower pays it off at the end of the first year.

M.G.L. Chapter 271, Section 49(a) provides for a criminal sentence of up to ten years and a fine of up to $10,000. Also, M.G.L. Chapter 271, Section 4(c) allows the court to void a usurious loan.

Massachusetts has two exceptions to usury. The first is the regulated lender exception in M.G.L. Chapter 271, Section 49(e). Under this exception, the usury statute does not apply to "any lender subject to control, regulation or examination by any state or federal regulatory agency" or to "any loan the rate of interest for which is regulated under any other provision of general or special law or regulations." This means that banks, credit unions and most conventional lenders are not subject to usury in Massachusetts. However, CMBS originators and investment funds may not fall under this exception.

The second exception is by use of a "leg-breaker letter." Under M.G.L. Chapter 271, Section 49(d), you can charge usurious interest as long as you send a letter to the Attorney General with the lender's and borrower's name and accurate address. This notification is good for two years.

The leg-breaker exception is very easy to comply with. I was surprised to see stories about usury in Massachusetts.

Both stories are about a loan for the development of a 186 home community and godf course in Dracut. Massachusetts Lawyers weekly reported the story: Release Won't Shield Lender from Usury Claim of Borrower subscription). It reports a story about LR5-A Limited Partnership v. Meadow Creek, LLC, et al. (Massachusetts Lawyers Weekly subscription), with a decision coming out of the Business Litigation Session of the Superior Court. The decision found that a release or waiver of claims for usury is not effective. Usury is a public policy law and cannot be waived by the parties. The case was also reported in the Boston Globe: Usury lawsuit names Harvard, Princeton, and Yale Endowments.

The borrower made notes with an interest rate in excess of 20%. The decision from the Superior Court says it was a 21% interest rate. The Boston Globe story says one of the loans was 42%. The lender was an investment fund set up by Realty Financial Partners. The lender was a non-conventional lender and therefore could not benefit from the regulated lender exception to the usury law. They should have filed a leg-breaker letter. The decision was silent on whether the filed a letter. The Boston Globe story reports that two notices were filed, but that one was filed too early (before the lending partnership was formed) and the second filed too late (after the loan was made).

The borrower goes on to charge the limited partners of the lender violated usury and is trying to bring a claim against them directly. This seems foolhardy from a legal perspective. But it apparently worked from a public relations perspective because he got his name in the paper

The problem I have with the application of the usury laws in commercial financing is that they merely give the borrower an opportunity to wiggle out from their bargain. According to the story, the borrower thought they could quickly obtain development rights and then refinance the loan with a conventional lender at a lesser interest rate. He failed and the lender had to foreclose on the property. The borrower must have thought the interest rate was acceptable at closing. Now that the deal went south, he is trying to apply the law retroactively to get himself out of his bargain.

Disclosure: Realty Financial Partners is a client of my firm.

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