Lenders often include fees in loan transactions in addition to an interest rate. Typically, these charges are not considered interest, as they compensate the lender for various services or commitments provided under loan agreements. However, a court may disregard the Escrow Fee Label when determining whether a loan has a usurious interest rate. The Michigan Court of Appeal, in Soaring Pine Capital vs Park Street Group, Docket No. 349909, did just that when it ruled that a 5% commitment fee should be considered interest in the facts of this loan transaction.
In Hovering pine, the plaintiff lender made a loan of $ 1,000,000 to the defendant borrowers to finance the rollover of homes purchased in foreclosure sales. The loan matured in one year and bore interest at 20% per annum, calculated on the basis of a 360-day year, an initial commitment fee of 5% paid at loan closing and funded by the loan proceeds, and a success fee of $ 1,000 from the eventual sale of each home. In addition, the first two months of interest accrued, but was added to the principal balance. The question in court was whether the loan had an interest rate that met or exceeded the 25% criminal usury rate under Michigan law.
The Court first looked at the simple 20% interest rate and found that, since it was calculated on the basis of a 360-day year, the 20% interest rate was in fact greater than 20% for the purposes of determining whether the overall rate was usurious. The Court then considered whether the 5% commitment fee paid at closing should be considered interest or a fee. The court rejected the lender’s argument that these charges were nothing more than charges. On the contrary, the commitment fee was only profit and was not part of a separate commitment from the lender because the lender did not commit to anything in exchange for the commission. In addition, the lender recovered all of its costs and expenses related to the granting of the loan through other fees paid by the defendants. Finally, the Applicant solicited investors for this loan program by qualifying the 5% fee as an “upfront charge” as part of the overall return that investors should expect in making the investment. Indeed, it seems that the Court found it very convincing that the lender solicited investors based on the fact that the commission was a profit on the loan in addition to the interest of 20%.
The Court also ruled that the savings usury clause in the loan documents did not prevent this particular loan from being considered usurious. Although it is not entirely clear, it appears that the Court found the savings clause ineffective because the commitment fee was intended to circumvent the limitation of usury from the start of the loan and did not become usurious because of a future event, such as the invocation of a default interest rate. It also appears that the Court found it convincing that the lender took legal action to collect the commitment fee in addition to the interest rate, and therefore knowingly sought to collect a usurious rate in connection with the litigation.
The Court concluded that the lender was not entitled to recover the interest on the loan as a remedy for the usurious interest rate. The Court did not consider whether the success fee should be considered interest or the impact of “interest on interest” following the accumulation of the first two months of interest.
In our current low interest rate environment, this view is unlikely to prompt regulated financial institutions to rethink the use of fees. However, these lenders should consider whether certain fees, such as renewal fees and extension fees, could result in an interest rate higher than the usury rate. Subprime lenders who provide high interest rate loans with significant additional fees should probably consider whether their overall return on a loan makes these loans usurious. In addition, it may be advisable, in a demand for payment or in legal action, to determine whether the return on the applicable interest rate with the charges is less than the usury rate.