Opinion ID: 1389352
Heading Depth: 1
Heading Rank: 9

Heading: Whether the settlement was a loan or forbearance

Text: (4) The constitutional proscription against usury applies by its express terms only to a ... loan or forbearance of any money, goods or things in action. (Cal. Const., art. XV, § 1.) Without a loan or forbearance, usury cannot exist. ( Southwest Concrete Products v. Gosh Construction Corp., supra, 51 Cal.3d 701, 705 ( Southwest Concrete ); see generally, 4 Miller & Starr, supra, § 10:3, p. 651; [The first essential element of a usurious transaction is a loan or forbearance of money.]; Comment, A Comprehensive View of California Usury Law, supra, 6 Sw.U. L.Rev. 166, 175 [It is imperative to remember that there must always be a lending or forbearance ... for the question of usury to arise.].) (5a) Antonioli contends the settlement transaction was neither a loan nor a forbearance. We agree. Viewed in the context of the transactions leading to this action, the settlement notes bear none of the attributes of a loan. To paraphrase Justice Mosk's often-quoted invocation of folk wisdom, if it does not look like a duck, does not walk like a duck, and does not quack like a duck, it is not likely to be a duck. ( In re Deborah C. (1981) 30 Cal.3d 125, 141 [177 Cal. Rptr. 852, 635 P.2d 446] (conc. opn. of Mosk, J.); Phillippe v. Shappell Industries (1987) 43 Cal.3d 1247, 1256 [241 Cal. Rptr. 22, 743 P.2d 1279].) We are not suggesting that courts should not look beyond the surface of a transaction. To the contrary, Sensitive to the ingenuity and creativity of those entrepreneurs willing to engage in legal brinkmanship to maximize profits, courts have carefully scrutinized the form of seemingly innocuous commercial transactions to determine whether the substance amounts to a usurious arrangement. ( DCM Partners v. Smith, supra, 228 Cal. App.3d 729, 733; Southwest Concrete, supra, 51 Cal.3d 701, 705.) Nevertheless, when the transaction bears none of the indicia of a loan, and, as in this case, there has been a finding that ... none of the parties on either side thought of the possibility of usury, we are reluctant to characterize the transaction as a loan. Doing so would be the judicial equivalent of pounding a square peg into a round hole. Ghirardo fails to meet his burden of establishing that the two settlement notes were loans or forebearances. Ghirardo contends the restructuring  that is, the execution of the two notes  effected a constructive transfer of funds by Antonioli on behalf of Ghirardo and created a debtor and creditor relationship between himself and Antonioli. Ghirardo's premise is that such a relationship establishes a loan. That is too broad. (6) To be sure, A loan transaction contemplates a debtor-creditor relationship with an obligation of the `debtor' to repay the amount of the loan to the creditor.... (4 Miller & Starr, supra, § 10:3, p. 651.) The converse, however, is not necessarily true. The creation of a debtor-creditor relationship does not, without more, constitute a loan. (5b) Antonioli transferred his interest in the real property to Gay in exchange for his promissory note and deed of trust. There was no loan, only a sale. ( Boerner v. Colwell Co., supra, 21 Cal.3d 37, 47.) The same was true of the transfer from Gay to Ghirardo. These sales were exempt from the usury law under the credit-sale or time-price doctrine. (7a) This doctrine applies when property is sold on credit as an advance over the cash price. In these circumstances, the seller finances the purchase of property by extending payments over time and charging a higher price for carrying the financing. This type of transaction, often called a bona fide credit sale, is not subject to the usury law because it does not involve a loan or forbearance. ( Southwest Concrete, supra, 51 Cal.3d at p. 705; Boerner v. Colwell Co., supra, 21 Cal.3d at p. 45; Verbeck v. Clymer (1927) 202 Cal. 557, 563 [261 P. 1017]; Cal. Real Property Financing (Cont.Ed.Bar 1988) § 5.46, p. 264.) Ghirardo does not dispute the continued validity of this long-standing doctrine. (5c) The question is whether the settlement notes come within this exemption from the usury law. The focus of the parties' disagreement on this question is DCM Partners v. Smith, supra, 228 Cal. App.3d 729 ( DCM ), in which the owner of real property sold it in exchange for a promissory note and deed of trust from the buyer. That transaction was exempt as a bona fide credit sale. When the buyer thereafter became unable to pay the note when due, the buyer requested an extension of the maturity date. The seller agreed in exchange for a 50 percent increase in the interest rate, from 10 percent to 15 percent. The buyer paid the extended note, then filed an action claiming usury. The Court of Appeal held that usury law does not apply ... to a modified purchase money secured note initially created in an exempt transaction, the bona fide sale and purchase of real property, where the modification, done at the request of the trustor, consisted solely of increasing the rate of interest to reflect market conditions in consideration of extending the due date of the note. ( Id., at p. 732.) The Court of Appeal in the present case both rejected and distinguished DCM's reasoning. As we shall explain, we believe DCM represents the better view and that it properly applies to this case. We begin with the important premise, which Ghirardo does not dispute, that his purchase of the property from Gay was exempt from the usury law. (Indeed, Ghirardo's note to Gay bore an interest rate of 11.5 percent and would have been usurious if not exempt.) Nor is there any question that Antonioli's prior sale to Gay was also exempt. Neither transaction involved a loan or forbearance. If Gay defaulted (as a result of Ghirardo's alleged default to Gay), Antonioli had two practical alternatives: (1) he could foreclose the property; or (2) he could agree to replace the Gay note with a new note that extended the time for payment. Antonioli initially chose the former, but Ghirardo agreed to the latter for the obvious reason that foreclosure would have resulted in the loss of his property. Ghirardo now contends Antonioli should be punished because he allowed Ghirardo to keep his property. This is hardly a sympathetic argument. We are not persuaded that a modification of a nonusurious transaction  a credit sale  should be subject to usury. (7b) The underlying policy of the credit-sale exemption is that, `On principle and authority, the owner of property, whether real or personal, has a perfect right to name the price on which he is willing to sell, and to refuse to accede to any other. He may offer to sell at a designated price for cash or at a much higher price on credit, and a credit sale will not constitute usury however great the difference between the two prices....' ( Boerner v. Colwell Co., supra, 21 Cal.3d 37, 45, quoting Verbeck v. Clymer, supra, 202 Cal. 557, 562.) (5d) We see no practical reason why the same rule should not obtain when the seller has already transferred title and is about to foreclose on the purchase money note. Just as he had an initial right to sell the property on any price terms he wished, he has the right to foreclose and to resell the property as he sees fit, at any interest rate, including reselling to the initial buyer. Precluding him from renegotiating with the buyer would elevate form over substance. Ghirardo, however, contends the credit-sale exemption should not apply because at the time of the modification, Antonioli had nothing to sell, that is, he already had sold the property to Gay. We believe the DCM court, supra, 228 Cal. App.3d at page 739, stated the better view: In saying Smith [the original seller] had nothing to sell[,] DCM wishes to minimize the value of Smith's `right to foreclose.' While there is a significant difference between a trustor of a secured note and an equity owner of improved real property, the latter status can be readily achieved by the former in a case like the one before us. Had the Smiths declined DCM's invitation to renegotiate they would have entered DCM's default when it failed to make the balloon payment on the due date of the note and foreclosed on the property. At a modest cost the Smiths would have become owners in the property with DCM losing its payments on principal and any increased equity resulting from appreciation. Thus the same factors influencing the Smiths' initial decision to sell were present when they later agreed to renegotiate the note. These factors included the parties' respective desires to be an equity owner of improved real property or a secured lender, interest rates on loans available from institutional lenders and tax benefits such as the deferral of gain to the seller on an installment sale and the deductions available to the buyer for interest payments. From our perspective [the] depiction of the parties as being in substantially different circumstances when they renegotiated the secured note compared to their position at the time of initial sale is not borne out by the realities of the transaction. Such result would also be unnecessary to achieve the purpose of the usury law, which is ... to protect the necessitous, impecunious borrower who is unable to acquire credit from the usual sources and is forced by his economic circumstances to resort to excessively costly funds to meet his financial needs. Such a person does not have the same need to purchase property, and he does not need the public policy of the State for protection. (4 Miller & Starr, supra, § 10:4, p. 656, italics added, fn. omitted.) As Ghirardo himself acknowledges, Parties buying property are under no compulsion to accept a high rate of interest; they can simply walk away if they cannot afford the price. The same can be said of a land developer like Ghirardo. He was under no compulsion to buy the property, including its being subject to the Gay note to Antonioli. When his development plans went awry, he could simply have walked away. Instead, he wanted to keep the property and agreed to retain it on new terms, in effect substituting his seller (Gay) with another, prior seller (Antonioli). We see no dispositive difference between this transaction and the initial, exempt sale. Ghirardo disagrees, contending that, although he did not have to buy the property, when the property was being foreclosed he became the necessitous, impecunious borrower the law intends to protect.... Presumably, he means that because a borrower faced with foreclosure may now lose the property, he should somehow be treated differently than when he purchased the property. To be sure, he may lose the property, but he will do so only if the seller forecloses, and that is encouraged by the very rule Ghirardo advocates. Unless we were to embrace the notion that commercial transactions are based in altruism, we must reiterate that the seller  who is being defaulted against  has only two options: foreclosure or extension of the note. If, however, an extension will bring the transaction within the usury law, the seller is left with only the foreclosure alternative. `The lender who wishes to accommodate the borrower either must force the borrower into a hardship position to pay or lose the security for the loan, or extend the loan and commit usury.... The imposition of the usury limitations in such cases merely harms the impecunious borrower that the law is intended to protect.' ( DCM, supra, 228 Cal. App.3d at p. 737, quoting 4 Miller & Starr, supra, § 10:12, p. 704.) We agree. The quoted commentators qualify their support for this view by stating that the extension should be treated as exempt only if the interest rate for the extension stays the same as the original rate or is reduced. (4 Miller & Starr, supra, § 10:12, p. 704.) Like the DCM court, supra, 228 Cal. App.3d at page 737, we reject this qualification. First, it would be unfair to both sides of the transaction. The only alternative to foreclosure for a seller who has suffered a default should not be an extension on more favorable terms to the buyer. That is unfair and impractical. Indeed, for that reason, it also prejudices the buyer who wishes to renegotiate because a seller who has two choices  foreclosure or extension on new terms favorable only to the buyer  will plainly be more likely to foreclose. Second, the extension for a reduced rate of interest could violate the usury law under Ghirardo's view that an extension of initially exempt debt (e.g., a credit sale) removes the exemption. As the DCM court, supra, 228 Cal. App.3d 729, explained, under that view, if the new, lower rate of interest was itself above the legal maximum, the extension would be usurious even though the higher, initial rate was not. It seems to us that the `law' should function in a rational manner to avoid a somewhat absurd and clearly inequitable result where the parties themselves are unable to distinguish between the bargains except the date on which each was made. Powerful reasons should exist before the law transmutes a legal transaction into an illegal one, particularly where the illegality places the entire financial burden on one party with the other seemingly unjustly enriched by having the benefit of an interest-free loan. ( Id., at p. 735.) Ghirardo not only asks us to reject DCM, supra, 228 Cal. App.3d 729, but attempts to distinguish it from the present case on two grounds. First, he points out that in DCM the modification was between the original parties to the credit sale, whereas in this case the settlement notes were not between the original parties to the sales, Antonioli and Gay for the first sale, and Gay and Ghirardo for the second sale. We do not see the logic of the distinction. The goals in DCM and in this case were the same  to extend the time for payment of notes exempt under the credit-sale doctrine. Moreover, the attempted distinction elevates form over substance. If, under DCM, Antonioli could have modified the Gay note to provide an increased rate of interest, we see no reason why Antonioli should not be able to cancel that note and provide the increased rate in a new note. Second, Ghirardo points to a footnote in DCM in which the court noted that, We wish to emphasize that Smith [the seller] did not receive any additional charges, fees or, consideration [for the modification] other than to increase the interest rate to reflect market conditions. ( DCM, supra, 228 Cal. App.3d at p. 737, fn. 5.) The DCM court also noted that in two prior decisions on which Ghirardo relies, [T]he beneficiary of the secured note extracted a substantial cash premium as part of the consideration for the modification. ( Id., at p. 738.) In the present case, the trial court found that as part of the settlement Ghirardo agreed to pay $100,000, which was a fee, bonus, commission or other compensation for forbearance and extension of credit. Thus, Ghirardo contends DCM, even if correct, is distinguishable. We are not persuaded that the noted comments were essential to the DCM court's reasoning or that they render DCM distinguishable from the present case. The relevant fact is not how the payments are characterized but whether they are in fact interest. In DCM the stated interest rate was increased from 10 percent to 15 percent, a rate that exceeded the legal maximum. In the present case, the asserted maximum rate was exceeded because the $100,000 additional payment was deemed to be additional interest. We do not believe the DCM decision would have been different if the 10 percent facial interest rate had remained unchanged, but a bonus payment had increased the effective rate to 15 percent. In either case the relevant figure would have been the 15 percent effective interest. Moreover, in distinguishing DCM, supra, 228 Cal. App.3d 729, the Court of Appeal in the present case seemed to suggest that DCM was based on a notion of fairness, including the fact that the increase in that case from 10 percent to 15 percent exceeded the then legal maximum of 14 percent by only 1 percent, whereas the rates of 13 percent and 17.46 percent in this case exceeded the 10.5 percent maximum by greater margins. This is not a valid distinction. Whether a transaction violates the usury law does not depend on the margin by which the maximum rate is exceeded. There is no such thing as a little usury. In short, the settlement and the resulting notes were substantially similar to the credit-sale modification approved in DCM, supra, 228 Cal. App.3d 729, and we conclude the rule stated in that case is sound. Thus, the settlement notes were the functional equivalent of a modification to an originally exempt credit sale. Such a modification is not subject to the usury law.