The Virginia Supreme Court has, on numerous occasions, indicated its refusal to recognize the form of transactions that are nothing more than devices used by money lenders to conceal usurious loans.
For example, in Patterson v. Shaver, 165 Va. 298 (Va. 1935), the court stated:
- A contract fair upon its face may be but a device to conceal a usurious transaction, but proof of this must appear by clear and cogent evidence.
The court in Van Dyke v. Commonwealth, 178 Va. 418, 17 S.E.2d 366 (1941) made the following observations in connection with analyzing a particular contract:
- Contracts of this character are scrutinized with care, and courts are alert to discover specious devices. The debtor often belongs to a class which needs protection, and his needs are sometimes so urgent as to extort from him any conditions which the creditor seeks to impose ...
- The cupidity of lenders, and the willingness of borrowers to concede whatever may be demanded or to promise whatever may be exacted in order to obtain temporary relief from financial embarrassment, as would naturally be expected, have resulted in a great variety of devices to evade the usury laws; and to frustrate such evasions the courts have been compelled to look beyond the form of a transaction to its substance, and they have laid it down as an inflexible rule that the mere form is immaterial, but that it is the substance which must be considered.
- The need to scrutinize with care loans made to borrowers caught in financial distress continues to be a valid concern. Moreover, it remains necessary today, as in 1941, for courts to look beyond the mere form of a transaction and analyze its substance.
Further, in Chakales v. Djiovanides, 161 Va. 48 (Va. 1933), the court stated:
- The fact that a lender has to borrow from a third person the money loaned by him does not give the lender license to charge the borrower more than the highest lawful rate of interest for the loan of the money. If he does so, directly or indirectly, under whatever guise the charge in excess of lawful interest may be cloaked, the loan is usurious. Richeson v. Wood, 158 Va. 269, 163 S.E. 339, 82 A.L.R. 1189; Roanoke Mtg. Co. v. Henritze, 151 Va. 220, 144 S.E. 430.
In Heubusch v. Boone, 213 Va. 414; 192 S.E.2d 783; (Va. 1972), the court recognized their duty to determine, and be controlled by, the substance of a transaction, rather than its form:
- "In determining the fact of usury, courts are not bound by the form which the transaction took; on the contrary, it is not only the right but the duty of the court to probe behind the written contracts, and to examine all facts and circumstances which shed any light upon the true nature of the transaction." Massie v. Rubin, 270 F.2d 60, 62 (10th Cir. 1959).
The following case is an example of the type of device that the Virginia Supreme Court has not allowed in circumventing the law on usury.
(In form, this case may not appear to be exactly on point with a contemporary foreclosure rescue transaction. However, I'll let the reader decide how close to the point it is.)
It involved a transaction where a loan of money was made to a property owner in urgent need thereof, and in exchange therefor, the lender received a secured note bearing the maximum interest rate allowed by law and, in addition, an option to buy the borrower's property (a three hundred acre farm) at a price well below fair value. The lower court ruled that the contract was unenforceable, and the Virginia high court affirmed, stating that the contract was unenforceable as being harsh, unconscionable and usurious. The court observed that "[i]f such a contract were sanctioned by this court, it would engraft a dangerous principle upon the law of usury."
Carter v. Hook, 116 Va. 812; 83 S.E. 386 (Va. 1914)
The facts of this case are summarized as follows:
1) One, Hook, was under necessity to raise money of which he was in urgent need.
2) He went to Carter for the loan, and Carter loaned him $ 1,100, for which he agreed to execute his note bearing 6% interest, and to secure the payment thereof by deed of trust.
3) In addition to receiving a secured note for $1,100, Carter also received an option to buy 300 acres of Hook's property that, by Carter's own testimony, was worth between $8,000 - $10,000.
4) The option price for Hook's property was set at $3,600.
5) The option contract provided that the $ 1,100 with all interest that had accrued thereon should be deducted from the $ 3,600 to be paid for the land, if the option to purchase was exercised within one year from the date of the contract.
6) Within the twelve months he notified Hook that he desired to purchase the property and tendered to him $ 3,600, less the $ 1,100 with interest to date.
7) Hook refused to convey and Carter brought an action for specific performance.
8) Hook alleged a gross and unconscionable inadequacy in price for the property, and inequitable conduct in that, because Carter knew of Hook's "dire pecuniary necessities," Carter took advantage thereof, and harshly and unconscionably oppressed him and caused him to both bind himself to pay interest at the rate of 166.10 per cent, and to also bind himself to agree to sell him the tract of land for $ 3,600.
9) The lower court ruled in favor of Hook, determining that the contract with Carter was unenforceable and accordingly, dismissed Carter's action. Carter appealed.
In affirming the lower court in ruling that the contract was unenforceable, the Virginia high court first commented that the "option for the purchase of a valuable tract of land [was one] to which Hook's necessities, but not his will, consented."
It then made the following analysis of the usury law and gave its conclusion in the case (bold text is my emphasis):
- Usury is defined in the 2nd edition of Black's Law Dictionary as being, "A premium or compensation paid or stipulated to be paid for the use of money borrowed or returned, beyond the rate of interest established by law." Wherever, therefore, by the terms of a contract, money is loaned and the lender is paid or stipulates to be paid a valuable consideration in excess of the rate allowed by law, the contract is usurious.
- In Stribbling v. Bank of the Valley, 5 Rand. 132, it was held that "When a proposition is made for a loan of money, and the lender will only consent to lend a part of the money wanted on condition that the borrower shall receive stock at a price much above the market value, to make up the deficiency, and the bargain is made on these terms, such contract is usurious."
- That case came again before the Court of Appeals in 7 Leigh 26, where it was held that where there was a sale of stock at an exorbitant price, coupled with a loan of money, arising out of a proposition to borrow money, the sale and the loan constituting one entire contract, inseparably connected with each other, and the one made dependent upon the other, the transaction was usurious.
- The principle of the cases just cited is precisely applicable to the one under consideration. In those cases the loan was made on condition that the borrower should purchase stock owned by the lender at a price much above the market value; while in the case before us the loan was made upon condition that the borrower should sell a farm to the lender at about forty per cent. of its actual value. If such a contract were sanctioned by this court, it would engraft a dangerous principle upon the law of usury. It would enable the lender to say, "You have a horse, a jewel, or a farm, which I crave, and in return for this loan you must pay me six per cent. interest, as allowed by law, and give me an option upon that which I covet."
In my view, there are arguably enough similarities between the transaction in this case and the typical foreclosure rescue transaction to assert that, in many cases, the latter transaction is a disguised (and possibly usurious) loan based on this case. The differences in the transactions are, arguably, not substantive. They center simply on the specific labels one gives to the legal documents used to consummate each transaction (ie. deed vs. option to buy/repurchase), and a utilization of a simple reversal in the mechanics of the transaction.
In Carter v. Hook, it's the property owner who got to hold absolute title to the property while the lender received an option to buy with terms so favorable that its exercise was a foregone conclusion. In the typical foreclosure rescue transaction, it's the lender (ie. foreclosure rescue operator) who gets to hold (acquire) absolute title to the property, and does so at extremely favorable terms while the property owner gets the option to buy/repurchase (typically with an accompanying leaseback agreement) with terms so unfavorable that either default (on the leaseback) or expiration (on the option to buy / repurchase) is a foregone conclusion. In effect, the property owner's option to repurchase is no option at all, unfair and lacking in good faith, arguably a mere sham.
In either case, however, if the substance of these transactions were to be disregarded, and the transactions were to be sanctioned by the court based on its form, the financially strapped property owner will more often than not end up being an "ex-property owner," stripped of any equity he/she may have had.
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