Opinion ID: 1174727
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Heading: 2b 3. Since the parties agreed to a variable-interest rate which could exceed the constitutional limits under certain contingencies, the lawfulness of the agreement depends on whether the parties contracted in good faith and without intent to avoid the usury laws.

Text: As we noted earlier, plaintiffs and defendant entered into an agreement which provided for a variable interest rate. Because of an increase in the call money rate, defendant, pursuant to that agreement, charged interest in excess of 10 percent from July 5, 1973, until September 26, 1973. The issue before us is whether such charges violated the usury laws, specifically section 2 of the initiative act as modified by the 10 percent limitation on interest of article XX, section 22, of the California Constitution. While the instant case was pending on appeal, the Court of Appeal published its opinion in Arneill Ranch v. Petit (1976) 64 Cal. App.3d 277 [134 Cal. Rptr. 456]. The opinion of Justice Potter in Arneill Ranch elucidated the principle that a variable-interest rate agreement, although it provides under certain conditions for interest charges in excess of 10 percent, does not violate the prohibition of excessive interest if the parties contracted in good faith and without intent to avoid the usury laws. Our discussion of the issue of excessive interest in the present case follows the analysis of Justice Potter in Arneill Ranch. In Arneill Ranch, the debtor signed a note providing for interest `at the rate of 7 1/2 percent per annum, or at the prime rate plus 2 percent ..., whichever is greater.' (64 Cal. App.3d at p. 280.) Because of increases in the prime rate, interest charged the debtor in Arneill Ranch for the period April 1, 1973, to October 1, 1973, equalled 10.008 percent, and during the period October 1, 1973, to April 1, 1974, equalled 11.46 percent. Maintaining that the note was usurious, the debtor sued for treble damages. The first question to be resolved in both Arneill Ranch and the present case was the length of the period over which interest would be computed to determine whether the rate of interest was usurious. As in the instant case, the trial court in Arneill Ranch held that the usurious character of the interest charge must be determined over the full period of the loan. Since the total interest charge in Arneill Ranch, spread over the entire period of the loan, did not exceed 10 percent, the trial court concluded that the note was not usurious even though the interest charges for some interim periods exceeded 10 percent. The Court of Appeal in Arneill Ranch, reversing the trial court, pointed out that all cases which sanction averaging of interest over the original full period of the loan involved situations in which the total compensation to the creditor included some charges on account of the total loan period which, when spread throughout such period, did not produce a total return in excess of the maximum rate but, by reason of the debtor's voluntary shortening of the term, did produce such excess. (64 Cal. App.3d 277, 290; citing French v. Mortgage Guarantee Co. (1940) 16 Cal.2d 26, 29-32 [104 P.2d 655, 130 A.L.R. 67] and cases there listed.) Under such circumstances, averaging interest over the original entire term serves the purpose of preventing the debtor, by default or premature payment, from unfairly transforming an innocent transaction into a usurious one. The present case is quite different from those decisions which established the general rule that interest should be averaged over the full term of the loan; indeed, in the present context such a rule would prove unworkable. Plaintiffs' margin account contemplates a credit arrangement of variable interest, of indefinite duration, and fluctuating balance. If interest were to be averaged over the full term of the loan, there would be no way to determine whether an existing credit arrangement were lawful or not; that issue could not be resolved until the account were closed, and either debtor or creditor by choosing the right moment to close the account could cause the interest over the term to exceed lawful rates. (5) As Arneill Ranch explained (see 64 Cal. App.3d at p. 293), when an agreement provides for a variable-interest rate, no agreed total profit to the lender can be averaged over the entire period of the loan. Under such circumstances, the interest payable for each portion of the loan term is the compensation to the lender for his forbearance from requiring immediate payment of the principal sum during that specific portion of the term. Thus the fact that the average interest charge on a variable-rate loan does not exceed the maximum rate is not in itself sufficient to establish that the loan complies with the usury laws if the interest charged for a particular period of forbearance exceeds the legal limit. (2c) That conclusion brings us to the question whether an agreement which provides for variable interest which under some contingencies may exceed the constitutional limit is usurious. Although two prior cases ( Calimpco, Inc. v. Warden (1950) 100 Cal. App.2d 429, 450 [224 P.2d 421]; Penziner v. West American Finance Co. (1933) 133 Cal. App. 578, 590 [24 P.2d 501]) state that an agreement is usurious if a contingency not in the borrower's control causes the excess interest, both cases involved agreements allegedly designed to evade the usury laws. (See Arneill Ranch v. Petit, supra, 64 Cal. App.3d 277, 284-285.) On the other hand the majority of decisions uphold the legality of a variable interest agreement if the transaction was consummated in good faith without intent to avoid the usury laws. ( Arneill Ranch v. Petit, supra, 64 Cal. App.3d 277, 289; Thomassen v. Carr (1967) 250 Cal. App.2d 341, 346-348 [58 Cal. Rptr. 297]; Wooten v. Coerber (1963) 213 Cal. App.2d 142 [28 Cal. Rptr. 635]; Schiff v. Pruitt (1956) 144 Cal. App.2d 493, 499 [301 P.2d 446]; Miley P. Corp., Ltd. v. Amerada P. Corp. (1936) 18 Cal. App.2d 182, 189 [63 P.2d 1210]; Lamb v. Herndon (1929) 97 Cal. App. 193, 201 [275 P. 503]; Jameson v. Warren (1928) 91 Cal. App. 590, 595 [267 P. 372]; see Rest., Contracts, § 527.) The recognition of the right of the parties to contract in good faith for a variable-interest rate, even though such a rate may at times exceed the constitutional maximum, not only finds support in the weight of authority but also in practical good sense. In the present case, for example, defendant asserts that it borrows the money that it lends plaintiffs at a rate of interest, the call-money rate, set by factors not within the parties' control. Thus the parties may reasonably agree that defendant's loans to plaintiffs will bear interest at a rate which varies in unison with the call-money rate. Although at times when the call money rate is high plaintiffs may be paying more than 10 percent interest, when at times the rate is lower plaintiffs may be charged less than the maximum legal rate. A strict construction of the usury laws without consideration for the characteristics of variable-rate loans would force defendant, whenever confronted with high call-money rates, to choose between calling in its margin loans or advancing money for less than cost, even though defendant entered into the margin agreements in good faith and without intent to avoid the usury laws. Therefore, assuming that defendant did in fact charge interest at a rate in excess of 10 percent during the summer of 1973, the lawfulness of that charge turns on whether the parties acted in good faith and without intent to avoid the usury laws, or merely cast the transaction as an agreement for a variable rate of interest as a colorable device to obtain a greater profit than was permissible under [the usury] laws. ( Arneill Ranch v. Petit, supra, 64 Cal. App.3d 277, 289.) Although the documents before us on appeal appear consistent with good faith, plaintiffs, as the issues were framed below, were not called upon to contest defendant's good faith and the court did not place its decision on the ground of good faith. (See Arneill Ranch v. Petit, supra, 64 Cal. App.3d 277, 294.) The issue of good faith thus remains a matter which must be resolved by the trial court.