Is Your Loan in Violation of State Usury Laws? by By Joel Glick, CPA/CFF, CFE
Posted on October 06, 2014
The mention of usury often brings to mind predatory payday lenders and loan sharks. However, the practice of charging an excessive rate of interest often occurs in traditional financial transactions as well. Frequently, it is an unintended consequence of either or both parties failing to understand the nuances of state laws and lacking the skill to carefully calculate and analyze the characteristics of interest and fees over the life of a loan. In Florida, the calculation of interest is based on the intent and terms at the time of signing and assumes the obligation will be paid according to those terms. Therefore, it is important for lenders and borrowers to understand the terms of any agreement into which they enter.
Florida Usury Laws
Under Florida statutes, usury is defined as the charging (whether paid or not) of interest that exceeds 18 percent on loans, lines of credit, advances of money or any obligation of amounts up to $500,000, and that exceeds 25 percent for transactions involving amounts totaling more than $500,000. Loans with an interest rate between 25.01 percent and 45 percent are criminally usurious misdemeanors, while a rate above 45 percent is punishable as a third-degree felony. The challenge with avoiding a potentially usurious transaction lies in the intricacies found in the agreement, the characterization of the various fees reflected in the agreement, and, in some instances, the determination of whether the agreement is intended as the acquisition of an equity interest in the venture or the issuance of a debt obligation.
Characterization of Transaction Fees
Late fees, exit fees, commitment fees, underwriting fees, origination fees and discount points are examples of common fees that may be charged in a typical loan. However, these fees, charged by lenders, have the potential of putting lenders at risk of violating state usury laws. The courts may include these fees, especially if they are neither reasonable nor customary, in the calculation of interest to be spread over the full term of a loan, which may potentially result in the effective interest rate exceeding the legal limit. Knowing what fees may be deemed as interest is important to ensure compliance with usury laws. Both lenders and borrowers should consult legal counsel before entering into any financial obligation.
In some instances, an agreement may stipulate that, in addition to the transaction fees, lenders receive an amount tied to the value of the venture to which they are lending. For obligations exceeding the $500,000 threshold referenced above, the value of this amount charged is not included in the calculation of interest. Examples are stock options, an interest in profits or residual values.
Characterization of the Agreement as an Equity Interest versus a Debt Obligation
If a lending agreement is determined to be a purchase of an equity interest in the venture, then usury laws do not apply and there are no caps on the “return” the purchaser can charge. There are factors as to the characteristics of debt versus equity, which the courts have relied upon when determining the nature of the obligation.
360 or 356 Days? Computing Interest
Very often, lending contracts are based on a 360-day year. However, under usury laws, the “per annum” in the statute is based on a 365-day year. Lenders can be surprised to learn those extra five days can turn an otherwise non-usurious loan usurious. Consider a lender who charges the maximum interest of 18 percent on a one-year, $500,000 loan based on a 360-day year. The annual interest charge is $90,000, resulting in a daily rate of $250 ($90,000 / 360 days). However, because usury laws are based on a 365-day year, the resulting interest charged is actually $91,250 (365 days x $250/day), resulting in an interest rate of 18.25 percent ($91,250 / $500,000) and, therefore, creating a usurious loan.
The usury statute does not prohibit the use of compound interest; however, the lawful rates established by the statute are based on simple interest. Therefore, it is equally important that lenders be careful when compounding interest to ensure the total amount charged does not exceed lawful interest rate limits. Consider a lender who charges 17 percent interest on a one-year $500,000 loan, compounded monthly. The interest payable is $91,946. The ensuing simple interest calculation results in a rate of 18.39 percent ($91,946 / $500,000), which is usurious.
Lenders and borrowers must keep a watchful eye on the various factors that have the potential to make lending transactions usurious. Failing to abide by state laws can result in forfeiture of all future interest as well as the return of twice the amount of interest the borrower already paid. In instances of criminal usury, the loan may become void, and the lender may be required to return any principal repayments as well as twice the interest received. To protect themselves from unintentional usury, lenders often will include savings clauses in their loan documents. However, Florida courts have ruled that such clauses are not a valid defense in and of themselves. Rather, they are but one element to be considered in usury claims.
The advisors with Berkowitz Pollack Brant’s Forensics and Business Valuations Services practice work closely with borrowers or lenders and their legal counsel to assist in identifying potential usurious terms prior to executing lending agreements as well as representing borrowers or lenders when allegations of usury arise.
About the Author: Joel Glick, CPA/CFF, CFE, is an associate director in Berkowitz Pollack Brant’s Forensic and Business Valuation Services practice. He can be reached in the Miami CPA firm’s office at 305-379-7000 or via email at firstname.lastname@example.org.