The U.S. District Court of the Central District of California recently dismissed a borrower's putative class action complaint against a non-bank that supposedly was the "true lender" for allegedly usurious student loans that were extended in the name of a bank.
In so ruling, the Court held California law requires that it must look only to the face of a transaction when assessing whether a loan falls under a statutory exemption from the usury prohibition and not look to the intent of the parties.
Under this rule, the Court held that the loans were exempt from California's usury prohibition under the California Constitution exemption for loans made by banks.
A copy of the opinion is attached.
On October 21, 2015, the borrowers filed a putative class action complaint claiming they had been illegally charged usurious interest rates on their private student loans in supposed violation of California law.
The borrowers obtained private student loans in 2003 and 2004 using loan applications that identified a national bank as the "lender." The borrowers alleged that the "actual lenders" of their loans were the Student Loan Marketing Association ("SLMA"), or subsidiaries of the SLM Corporation ("SLM Corp").
The borrowers alleged that the SLMA and the SLM Corp. subsidiaries originated, underwrote, funded and bore the risk of loss as to their loans under a confidential agreement (the "Agreement") between the SLMA and bank.
The borrowers also alleged that the Agreement provided that bank was required to sell the loans to SLMA at cost within 90 days of being funded. This arrangement then allegedly enabled SLMA and the SLM Corp. subsidiaries to make high-interest private loans to students like borrowers attending for-profit schools without the scrutiny of any bank regulatory body, and without the market restraints faced by regulated lenders.
The borrowers asserted that under the Agreement, SLMA and SLM Corp. subsidiaries made thousands of loans to California borrowers using banks as the nominal lender, with either SLMA or an SLM Corp. subsidiary functioning as servicer.
The borrowers alleged the non-bank defendants had been illegally charging and collecting interest at a rate greater than 10%. The borrowers' loans were originally assigned to SLMA or an SLM Corp. subsidiary after their disbursement and were subsequently sold to various other parties.
The SLMA was created pursuant to federal statute and chartered by the federal government as a government sponsored enterprise. In or about 1994, Congress required the SLMA to transition to a wholly private company no later than September 30, 2008. As part of the transition, various segments and subsidiaries of the SLMA were acquired by the SLM Corp., which continued the SLMA's operations during the transition period and after the SLMA's dissolution.
The borrowers alleged that in an effort to circumvent federal restrictions on its ability to originate loans and to circumvent state usury laws, the SLMA, and the SLM Corp. and its wholly-owned subsidiaries entered into forward purchase agreements with national bank partners, supposedly to make it appear that the lender was a national bank.
The borrowers asserted that the SLMA was effectively the "actual lender" of the loans in a number of ways. First, according to the borrowers, the bank did not have any risk of loss with respect to the loans because the SLMA provided the funds for the loans and agreed in advance to purchase the loans from the bank. Moreover, the borrowers asserted, the SLMA controlled all aspects of marketing loans to student borrowers, and required bank to print, package and distribute application materials in forms acceptable to the SLMA, based on a design template for such materials provided by the SLMA.
According to the borrowers, the bank was not allowed to alter the content or description of these application materials without the SLMA's express written consent. Instead, the borrowers asserted, the bank's role was to add its name, state, logo and OE number to the applications, which made it appear as if the bank were the lender. In addition, the SLMA allegedly set the terms of the private loans; controlled the schools at which the loans could be made; determined which students would be approved for loans and for what amounts; and determined the interest rate on a borrower's loan based on proprietary credit criteria established by the SLMA.
In 2004, the SLMA was dissolved and merged into the SLM Corp. At this time, the Agreement was amended, and the SLMA's role was assigned to two wholly-owned subsidiaries of the SLM Corp.
Based on the foregoing allegations, the borrowers asserted five state law claims: (1) unlawful and unfair business practices in violation of the California Unfair Competition Law ("UCL"); (2) usury in violation of Article XV, Section 1, of the California Constitution; (3) violation of California's Usury Law (i.e. Cal. Civ. Code § 1916-1); (4) claim for money had and received; and (5) conversion.
The borrowers' claims for money had and received and for conversion and violation of the UCL were predicated on the borrowers' theory that the non-banks had violated California's usury prohibition. The borrowers sought restitution, compensatory and statutory damages, and injunctive relief, and sought to represent a putative class of individuals residing in California who obtained student loans and were similarly charged usurious interest rates.
The defendant non-banks argued that the borrowers' complaint should be dismissed because: (1) the borrowers' loans are exempt from California's usury prohibition; and (2) the borrowers' claims are preempted by the National Bank Act.
The Court found that the borrowers' loans were exempt from California's usury prohibition, and did not reach the question of whether borrowers' claims were preempted by the National Bank Act.
The borrowers' usury claims were based on Article XV § 1 of the California Constitution, which provides that interest charged on an obligation in excess of 10% is usurious and therefore cannot be collected, and the California "Usury Law," Cal. Civ. Code § 1916-1.
Because the California constitutional provisions supersede any conflicting language in the state Usury Law, the Court looked to the controlling language of the California Constitution when assessing the borrowers' usury claims.
The essential elements of a claim of usury in California are: (1) the transaction must be a loan or forbearance; (2) the interest to be paid must exceed the statutory maximum; (3) the loan and interest must be absolutely repayable by the borrower; and (4) the lender must have a willful intent to enter into a usurious transaction.
The intent sufficient to support a judgment of usury does not require a conscious attempt, with knowledge of the law, to evade it. The conscious and voluntary taking of more than the legal rate of interest constitutes usury and the only intent necessary on the part of the lender is to take the amount of interest which he receives; if that amount is more than the law allows, the offense is complete.
The usury prohibition is subject to numerous exemptions. In particular, the California Constitution exempts from the usury prohibition loans made by any bank created and operating under and pursuant to any laws of the state or of the United States of America.
The non-bank defendants argued that the borrowers' usury claims should be dismissed because the borrowers' loans fell within the California Constitution's exemption for loans made by banks. The non-bank defendants noted that the complaint itself alleged that the borrowers' loans were originally issued by a bank.
Additionally, the non-bank defendants argued that the SLMA should not be considered the actual lender of borrowers' loans, because although the SLMA contracted with the bank to purchase the loans after they were issued and was involved in their issuance and disbursement, this does make SLMA the actual "lender" for purposes of the exemption from the usury prohibition.
The non-bank defendants also argued that under California law, the court could not consider whether the SLMA intended to circumvent the usury prohibition through its agreement with the bank when determining whether borrowers' loans were exempted from the prohibition.
Countering, the borrowers argued that the court must look to the substance of the transaction rather than to its form when assessing whether a loan falls into the exemption from California's usury prohibition. The borrowers further argued that the SLMA's intent is relevant to whether borrowers' loans were exempt from the usury prohibition.
The borrowers contended that although the bank was the lender of borrowers' loans "in form," the complaint sufficiently alleged that the SLMA was for practical purposes the actual lender and that the SLMA intended to skirt the usury prohibition through its agreement to purchase the loans from the bank. Consequently, the borrowers argued, their loans did not fall under the exemption from the usury prohibition for loans issued by banks.
The Court rejected the borrowers' arguments, noting that, even assuming the allegations in the complaint were true, the borrowers' loans fell under the California Constitution's exemption for loans issued by banks, and the borrowers' complaint alleged that the loans were issued by a bank.
Although the borrowers argued the exemption did not apply to their loans because their "lender" was effectively the SLMA, they failed to cite any authority supporting this proposition.
Instead, the borrowers cited a number of cases for the proposition that the court should look to substance over form to assess whether a loan, that on its face appears non-usurious, is in fact usurious, arguing that these decisions permitted the court to look at the "substance" of the SLMA's agreement with the bank and the SLMA's intent in order to determine whether the borrowers' loans were exempted from the usury prohibition.
The Court noted, however, that the cases cited by the borrowers only held that a court may consider the "substance" of a transaction over its "form" and the parties' intent when assessing whether a transaction satisfies the elements of usury or falls under a common law exemption to the usury prohibition, and not when assessing whether the transaction or a party to the transaction fall under a constitutional or statutory exemption from the usury prohibition.
Because the Court found borrowers' loans were exempted from the usury prohibition, the Court concluded that borrowers' remaining claims for money had and received, conversion, and violation of the UCL were also subject to dismissal.
In reaching its decision, the Court relied upon Jones v. Wells Fargo Bank, 112 Cal. App. 4th 1527, 1539 (2003) and WRI Opportunity Loans II LLC v. Cooper, 154 Cal. App. 4th 525, 533 (2007), two California appellate decisions that held that the court must look only to the face of a transaction when assessing whether it falls under a statutory exemption from the usury prohibition and not look to the intent of the parties.
In Jones, the California Court of Appeal, considering a plaintiff's claim that a shared loan appreciation agreement was usurious, noted that cases where intent to evade the usury law is at issue typically involve situations where the lender claims a transaction is not a loan at all and that defendants' intent was irrelevant where the agreement fit within a legally authorized exception to the general usury law.
In WRI, where two plaintiffs claimed a loan provided to their company was usurious, the California Court of Appeal re-affirmed Jones, noting that when a loan meets the requirements for a statutory exemption to the usury law, courts will not look beyond those requirements.
The borrowers attempted to distinguish Jones and WRI, arguing that those cases pertained to exempt transactions – i.e., shared appreciation loans. The borrowers contended that that when the exemption belongs to an entity in what otherwise would be a usurious transaction, the intent of the parties is critical.
The Court again rejected the borrowers' argument. The Court noted that the borrowers cited no authority supporting the proposition that the court's inquiry into a transaction subject to a usury exemption differs based on whether the exemption pertains to the character of the transaction or to that of a party to the transaction.
The Court concluded that the cases cited in support of borrowers' contentions were inapposite because they did not concern statutory or constitutional exemptions to the usury prohibition, and found Jones and WRI to be controlling.
The district court found Jones particularly on-point because it addressed a statutory exemption for certain national banks comparable to the constitutional exemption at issue in this case. Consequently, the district court looked only to the face of the transactions at issue when assessing whether borrowers' loans were exempted from the usury prohibition.
Because borrowers' complaint alleges that the loans were issued by a bank, the district court concluded that the loans were exempted from California's usury prohibition.
Accordingly, the Court granted the non-bank defendants' motion to dismiss insofar as it contended the borrowers' loans were exempted from California's usury prohibition, and dismissed the action with prejudice.
Eric Tsai
Maurice Wutscher LLP
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San Francisco, CA 94105
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Email: etsai@MauriceWutscher.com
Admitted to practice law in California, Nevada and Oregon
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