A. The Basic Concept

Schnee v. Plemmons

B. Typical Usury Problems

C. Exemptions from Usury Statutes

Trapp v. Hancuh

Problem Set 20

Problem Set 20

20.1. Your longtime client Jodi Kay (most recently from Assignment 19) calls you to ask you two usury questions about her standard form promissory note. On fixed-rate loans, she uses a form just like the form in Assignment 15. The Stated Rates of the notes in her current loan portfolio vary between nine and fourteen per cent per annum and between $1 million and $8 million in size. She would like you to prepare a brief memorandum for her files explaining why those notes are not usurious. What would your memorandum say? Tex. Finance Code §§303.002, 303.003, 303.009.

20.2. Tertius Lydgate retains you for advice regarding a simple loan transaction. Bulstrode Bank has offered to loan Lydgate $1 million for Lydgate’s medical clinic. Bulstrode has offered him a variable-rate loan at a rate of prime plus 1.5%. Prime currently is 7%. He understands that the variable-rate loan will leave him exposed to the risk of paying more if interest rates go up, but he wants you to quantify that risk for him. He tells you that the transaction takes place in Texas and that the note will be in the form set out in Assignment 15, with a revision of the Stated Rate provision to call for “a per annum rate of interest equal to the lesser of (a) the Maximum Lawful Rate; or (b) one and one-half percent (1.50%) per annum above the Prime Rate; the parties specifically agree that the monthly ceiling described in Texas Finance Code § 303.004 applies for purposes evaluating the lawfulness of the Stated Rate.” Lydgate wants to know three things.

(a) First, he doesn’t know anything about the “Maximum Lawful Rate” described in the Promissory Note. He wants you to tell him what that rate would be if the auction rate for 26-week treasury bills rose to 8%, 11%, 13%, and 15%? Tex. Finance Code §§ 303.004, 303.305, 303.009.

(b) Second, assuming that the auction rate always remains five percent per annum below the Prime Rate described in the Promissory Note, at what rate would interest accrue in the circumstances described in question (a)? Could Lydgate contest that rate as usurious? Promissory Note §2(d).

(c) Third, if the interest would not be usurious, can you think of any other way that he could sign the Promissory Note and still be in a position to avoid any legal obligation to pay interest at that high rate? Would bankruptcy help? 11 U.S.C. §1129(b)(2).

20.3. Ben Darrow (your long-time client, going all the way back to Problem Set 1) calls you for advice about a new loan product that he is designing for his bank, First State Bank of Matacora (FSB). Essentially, the product is designed to deal with potential small-business borrowers who fill out an application but decide not to borrow money from the bank after the bank goes to the trouble of evaluating the application. The way the product works is that the borrower makes an up-front interest payment of two percent of the loan at the time of the application. If the application is rejected, the money is refunded. If the loan closes, FSB applies the two-percent fee against interest accruing during the first two months of the loan. If FSB accepts the application but the borrower fails to close the loan (or repays the loan before the conclusion of the second month), FSB retains the two-percent fee. Assuming that Texas law applies, do you have a problem with that arrangement? Would your answer change if FSB was using that structure for home-mortgage loans instead of small-business loans? Texas Finance Code §§305.001, 305.002, 305.005.

20.4. After pondering the advice that you gave her in Problem 20.1, your friend and client Jodi Kay calls back about another variable-rate transaction using the form Promissory Note (just like the promissory note in Problem 20.2). In this case, however, the borrower has asked Jodi to remove §12 from the note. The borrower explains that it is not entirely sure exactly what it plans to do with the money. Jodi says that the potential borrower is quite creditworthy, and thus that she does not really have any concern about the request. Does the borrower’s request trouble you for any reason? Texas Finance Code §§303.004(a)(2), 303.004(c), 303.009(c).

20.5. A friend of yours named Bill Stewart runs a small local computer-services company. His company’s main line of work involves setting up and troubleshooting custom operating systems for area businesses. Because of the nature of his business, his company has relatively few tangible assets. From his perspective, the main asset of the company is his own expertise. Reflecting the lack of collateral and the relatively risky nature of the business, he has been financing his company with a $300,000 line of credit from a local bank that bears interest at a floating interest rate of prime plus 10%. When prime rose last week above eight percent, his bank called him and told him that it had decided to terminate the line of credit because applicable state law (slightly different from the Texas law set forth above) absolutely bars it from charging interest at a rate greater than 18% per annum.

Bill is satisfied that the loan documents permit the bank to terminate the line of credit. He also tells you that he is not unsympathetic to the bank’s concerns and would be happy to pay a return of 20% per annum if he could get the funds needed to keep his business going. What do you recommend?

Assignment Update