Penalties for a Usurious Commercial Transaction
In Texas, merely contracting for a usurious interest rate is sufficient for a borrower to assert a claim for usury. Tex. Fin. Code Ann. § 305.001(a-1) (West 2013); Bernie’s Custom Coach of Texas, Inc. v. Small Bus. Admin., 987 F.2d 1195, 1197 (5th Cir. 1993) (citations omitted). Of course, the lender’s actual receipt of usurious interest gives rise to a usury claim, as well. Tex. Fin. Code Ann. § 305.001(a-1). Subject to certain defenses the lender may raise, the borrower’s claim for usury entitles the borrower to recover two main penalties from the lender. First, the lender must pay the borrower three times the difference between the usurious interest and the maximum interest permitted by law. Second, the lender must pay the borrower’s reasonable attorney fees as set by a court. Tex. Fin. Code Ann. § 305.005 (West 2013).
Beware of “Disguised Interest”
Generally, Texas usury laws cap annual interest on a loan at 18% of the principal amount. See Tex. Fin. Code Ann. §§ 302.001, 303.009(a) (West 2013); Bair Chase Prop. Co., LLC v. S & K Dev. Co., Inc., 260 S.W.3d 133, 138–39 (Tex. App.—Austin 2008, pet. denied). The application of the law is relatively clear-cut with a simple loan that contains only absolute obligations to repay the principal amount borrowed plus interest. However, more sophisticated loans may contain contingent obligations—such as late fees, profit-sharing, or additional payments if the lender declines to convert the debt into equity—which courts may deem “disguised interest.” If, for any year of the loan, the amount of the stated interest and the disguised interest exceeds 18% of the principal amount, courts will probably find the loan usurious.
Confusion about Contingent Obligations
Texas law is unclear on the point of whether a contingent obligation may constitute disguised interest giving rise to usury. Fed. Sav. & Loan Ins. Corp. v. Griffin, 935 F.2d 691, 700 n.5 (5th Cir. 1991). One line of cases concludes that a contingent obligation may not be the basis for usury. See, e.g., Beavers v. Taylor, 434 S.W.2d 230 (Tex. Civ. App.—Waco 1968, writ ref’d n.r.e.); Fin. Sec. Servs., Inc. v. Phase I Electronics of W. Texas, Inc., 998 S.W.2d 674, 681–82 (Tex. App.—Amarillo 1999, pet. denied). However, a separate line of cases contends that “[a] contract is usurious if there is any mode or contingency by which the lender could receive more than the maximum rate of interest allowed by law.” See, e.g., Dixon v. Brooks, 678 S.W.2d 728, 729 (Tex. App.—Houston [14th Dist.] 1984, writ ref’d n.r.e); Grotjohn Precise Connexiones Intern., S.A. v. JEM Fin., Inc., 12 S.W.3d 859, 876 (Tex. App.—Texarkana 2000, no pet.). The Supreme Court of Texas provided some guidance on the issue by noting that it has endorsed Beavers for the proposition that a contingent obligation to pay an amount was a factor for determining whether the amount was disguised interest, specifying that the “uncertainty in the value of a contractual right that a debtor claims is interest casts doubt on whether that value can be characterized as interest.” First USA Mgmt., Inc. v. Esmond, 960 S.W.2d 625, 628 (Tex. 1997).
However, confusion over this issue has persisted. In 1999, the Amarillo court of appeals discussed both Beavers and Dixon before relying on Esmond to determine whether a contingent payment was disguised interest. Fin. Sec. Servs., Inc., 998 S.W.3d at 681–82. And in 2000, the Texarkana court of appeals cited only Dixon to determine if a conditional obligation rendered a loan usurious. Grotjohn, 12 S.W.3d at 876. Thus, Esmond may not have completely settled the contradiction between Beavers and Dixon, and even if Esmond reconciled these conflicting cases, one should pay close attention to Beavers and Dixon to anticipate how a court will likely view a conditional obligation.
Depending on the exact circumstances of a financing transaction, some contingent obligations may have the disastrous effect of exposing the lender to usury penalties, while others may afford the lender a flexible means to manage the risks of the transaction. As the usury penalties and the confusion in the case law indicate, the answer to whether a particular contingent obligation subjects a lender to Texas usury laws is both important and complex.
Of course, this is not an exhaustive discussion of the law applicable to these issues. For more information on this topic, please email Cade Mason at firstname.lastname@example.org or call him at (361) 886-3800.