Posted by: yarbel | 3rd Jun, 2015

The Acrobatics of Usury — Yonathan Arbel

Post By Yonathan Arbel

Perhaps one of the most plastic of all private law rules is the prohibition on usury. Judges and religious scholars have been pirouetting around this issue more-or-less gracefully for thousands of years. A recent interesting case in this regard is Bisno v. Kahn, 225 Cal. App. 4th 1087, 170 Cal. Rptr. 3d 709 (2014).  This case raises a question that is rarely asked: can a judgment-creditor charge any amount in exchange for delaying the execution of a judgment?

In a nutshell, the plaintiff (“debtor”) owed the defendant (“creditor”) $3.2 million dollars on a judgment entered for the creditor. The debtor had $60 million dollars locked in an escrow account that was tied to a real estate sale and he was worried that the creditor’s collection efforts might thwart the deal. The debtor therefore asked the creditor for ‘forbearance’, i.e., the postponement of execution of the judgment. The parties agreed that in exchange for a two month forbearance the debtor would pay (upfront) $522,000 dollars.

After receiving the extension, the debtor brought suit against the creditor, arguing that the forbearance payment was usurious and that the court should deduct the amount paid from the principal debt owed to the creditor.

According to California’s constitution one cannot charge more than 12 percent interest “upon any loan or forbearance of any money, goods or things in action.” (Cal. Const., art. XV, § 1 and  Civ.Code, § 1916 1-3).  So the question was whether the forbearance on the judgment owed is forbearance of a “thing in action.” The court ruled that it was not. The reason, the court explains, is that a “thing in action” refers to a right of action rather than an already adjudicated matter. In so ruling, the court relied on an earlier case (People v. Baker (1978) 88 Cal.App.3d 115, 119, 151 Cal.Rptr. 362.), which, surprisingly, seem to point in the opposite direction: it suggested that courts have given expansive interpretation to the term “thing in action.” It also stated that this term is understood to cover private property (rather than just a right to private property; citing back to Payne v. Elliot (1880), 54 Cal. 339, 341-42), and it would seem that a judgment and private property share important defining characteristics. In any event, based on this precedent and other grounds, the court ruled that forbearance payments cannot be considered usurious as usury laws exclude judgments.

Now, from an economic perspective things are very simple: if a person who is owed an amount of money is offering an extension of the date when payment is due, then this person is offering credit. The price charged is called interest. That the amount is owed due to a judgment rather than a loan is immaterial.  In this case, the rate charged on the $3.2 million judgment is equivalent to a nominal APR of 98%. This means that a one-year forbearance would have cost the debtor $3.2 million dollars—the same as the debt itself… To put things in perspective, charging this amount on the debtor’s credit card would only involve about 18% APR.

Based on the economic nature of the transaction, there is therefore a clear reason to view this transaction as falling neatly under the rubric of a credit transaction, contrary to the result reached by the court. In fact, economic analysis would suggest that if anything, it is judgments that should be subject to usury laws rather than the more general category of credit transactions. While most credit transactions are made in the open market and often involve a meaningful choice among alternatives, judgments involve a bilateral monopoly between the judgment-debtor and the judgment-creditor, thus suggesting room for regulation.

Usury laws are strange, riddled with exceptions, and often lack any coherent guiding principles. These laws set a-priori price caps that rarely if ever take into account all default risks and other costs; as such, they are arbitrary in nature and often lead to negative unintended consequences (See more generally in Richard Hynes & Eric Posner, The Law and Economics of Consumer Finance, 117 Am. L. Econ. Rev. 168 (2002)). Indeed, usury laws may be useful as crude proxies for cognitive faults, coercion, or fraud, but they should not be understood as independent reasons to limit transactions. When such rules are set as constitutional rights or as rigid statutory limits, courts will feel pressure to find creative ways to skirt around them.  Judicial acrobatics of this sort often are unconvincing and make for bad law. 

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