Lender's Improper Calculation Of Interest Sinks Foreclosure Action, Leaves It Holding The Bag On A Criminally Usurious Mortgage Loan Subject To Cancellation

(This post is a reprint of an entry originally posted on September 19, 2010.)

A recent court ruling by a Florida appeals court shows how a private mortgage lender, by engaging in certain practices, can find itself unwittingly holding the bag on what a court finds to be a criminally usurious loan that is unenforceable and subject to cancellation. A summary of the facts, adapted from the court's opinion, follow:

• One, Velletri, obtained a loan with a face amount of $250,000 from Providence Mortgage Corporation, which was a mortgage servicing company acting on behalf of Dixon, a private lender. The loan proceeds were to be used to purchase and renovate a commercial property in St. Petersburg.

• The loan was an "interest only" loan, and the loan documents indicated that Velletri would make twenty-three "interest only" payments of $3150 followed by a final balloon payment of $253,150. The stated interest rate of the loan was 15 percent.

• According to the closing documents, Providence withheld $12,500 from the loan proceeds as an "origination fee." It also withheld $513.70 as "interest."

• Further, to ensure that the proposed renovations were actually performed, Providence also withheld an additional $65,000 at closing as "construction loan funds," and it placed those funds into an escrow account from which Velletri could apply for reimbursement as the renovations progressed.

• However, despite the withholding of sums totaling $78,013.70 from the loan proceeds at closing, the $3150 "interest only" payment was calculated based on a 15 percent interest rate on the full $250,000 face amount of the loan.

• Providence assigned the note and mortgage to Dixon at closing.

• Ultimately, Velletri defaulted on the loan and Dixon filed his foreclosure action against the property.

• Velletri defended against the foreclosure action by raising the defense of usury. Velletri contended that the loan was criminally usurious from its inception and that therefore the note and mortgage were unenforceable.

• Dixon argued that the loan was not usurious because he had not received the funds withheld at closing and because he had no usurious intent.

• The Florida appeals court ultimately determined that, as a result of the lender charging interest on the entire face amount of the loan, without any abatement to reflect the withheld loan proceeds, the recalculated interest pushed the actual rate charged to over 25%, which under Florida law, constitutes criminally usurious interest, the remedy for which is cancellation of the debt itself and a return of any loan repayments made by the borrower.(1)

Grissim H. Walker, Jr., of Consumer Law Center, P.A., Bradenton, represented the borrower.

See Velletri v. Dixon, 44 So.3d 187 (Fla. 2d DCA, 2010) for the ruling, along with the actual number-crunching involved in the determination that the interest charged on this loan exceeded the maximum amount (25%) allowed on this type of loan under Florida law.(2)

Footnotes:

(1) The court's identification of the applicable Florida law in this case follow (bold text is my emphasis, not in the original text; my [alteration] added; cited statutes are found in Chapter 687, Florida Statutes:

• Sections 687.03, 687.04, and 687.071 provide statutory causes of action which allow a borrower to seek affirmative relief against a lender who has made a usurious loan.

• Civil usury involves loans of $500,000 or less with an interest rate greater than 18 percent and less than 25 percent.See § 687.03(1).

• Criminal usury involves any loan amount with an interest rate greater than 25 percent. See § 687.071(2).

• The penalties for civil usury include forfeiture of double the interest actually charged and collected. See § 687.04. The civil penalty for criminal usury is significantly greater: forfeiture of the right to collect the debt at all. See § 687.071(7).

• Whether a transaction is either civilly or criminally usurious is determined at the inception of the loan. See Home Credit Co. v. Brown, 148 So. 2d 257, 259 (Fla. 1962); Oregrund Ltd. P'ship v. Sheive, 873 So. 2d 451, 458-59 (Fla. 5th DCA 2004).

• If a borrower is required to pay a bonus or other consideration at the inception of the loan as an inducement to the lender to make the loan, such an inducement may be considered interest and can render an otherwise proper loan usurious. See Cooper v. Rothman, 57 So. 985, 988 (Fla. 1912); Jersey Palm-Gross, Inc. v. Paper, 639 So. 2d 664, 667 (Fla. 4th DCA 1994), aff'd, 658 So. 2d 531 (Fla. 1995).

• Similarly, if a lender retains a substantial portion of the loan proceeds without allowing a corresponding abatement of interest on the amount retained, that retention effectively increases the interest charged on the amounts actually advanced to the borrower, which can render an otherwise proper loan usurious. See Mindlin v. Davis, 74 So. 2d 789, 793 (Fla. 1954).

• Section 687.03(3) sets forth the methodology to be used to determine whether a loan is usurious when some of the loan proceeds have been retained by the lender at closing. The Florida Supreme Court applied this statutory methodology in St. Petersburg Bank & Trust Co. v. Hamm, 414 So. 2d 1071 (Fla. 1982), and specifically rejected any alternative means of calculating the effective interest rate of a loan.

***

• [L]oan proceeds retained by the lender are considered additional interest, see Brown v. Home Credit Co., 137 So. 2d 887, 892 (Fla. 2d DCA 1962), and do not reduce the "stated amount of the loan" identified in section 687.03(3), see Hamm, 414 So. 2d at 1073.

***

• Having determined that the note was criminally usurious at its inception, we must next consider what remedy is proper. Generally, a debt that is criminally usurious at its inception is not enforceable. See § 687.071(7) ("No extension of credit made in violation of any of the provisions of this section shall be an enforceable debt in the courts of this state."); Brown, 137 So. 2d at 892 ("[I]f the interest charged exceeds twenty-five percent per annum the lender shall forfeit the entire indebtedness, both principal and interest.").

• However, Velletri claims she is entitled to more than that. She contends that she should be entitled to both cancellation of the note under section 687.071(7) and an award of double the interest paid under section 687.04—essentially a combination of the remedies for both civil and criminal usury. But such a remedy would be improper.

• When a debt is criminally usurious, the remedy is cancellation of the debt itself and a return of any amounts paid. There is no authority for cumulating the penalties for both civil and criminal usury, and, in fact, the authority is to the contrary. See Rosenbloom v. Hart, 95 So. 2d 18, 19-20 (Fla. 1957) (noting that sections 687.04 and 687.071 recognize and define different degrees of usury and provide distinct and separate penalties which are not cumulative); Brown, 137 So. 2d at 893 (same); Gordon v. W. Fla. Enters. of Pensacola, Inc., 177 So. 2d 859, 862 (Fla. 1st DCA 1965) (same); Coral Gables First Nat'l Bank v. Constructors of Fla., Inc., 119 So. 2d 741, 748-49 (Fla. 3d DCA 1960) (same).

• Contrary to Velletri's assertions, no court has held that the remedies provided in sections 687.04 and 687.071(7) are cumulative of each other. Therefore, we reject Velletri's suggestion that she is entitled to both cancellation of the debt and payment of double the interest she paid. Instead, on remand, the trial court should enter a judgment in favor of Velletri on the foreclosure action and award her a judgment in the amount the evidence establishes that she actually paid Dixon.

(2) The private lender in this case found itself holding an uncollectible, unenforceable loan, despite the fact that the stated rate of interest on the promissory note itself was otherwise within the maximun limits, as a result of a judicial recharacterization of the withheld loan proceeds as additional interest.

Similarly, a foreclosure rescue operator (or anyone else, for that matter) can find itself in violation of the Florida usury statute as a result of a judicial recharacterization when peddling a sale leaseback arrangement that is combined with a repurchase right/option if such a transaction is ultimately recharacterized by a court as a secured loan/equitable mortgage, and where the "profit' on the deal (which would be recharacterized as "loan interest") exceeds the limits under Florida law).

See, for example, Oregrund Ltd. P'ship v. Sheive, 873 So. 2d 451, 458-59 (Fla. 5th DCA 2004), which involved a usury claim in the context of a sale-buyback deal in a civil case. See also Equitable Mortgage & Usury In Sale Buyback Deals In Florida. (Note that, to the extent the sale leaseback transaction falls within the purview of Florida’s Foreclosure Rescue Fraud Prevention Act, F.S. 501.1377(6) thereof creates a rebuttable presumption that the deal is a loan transaction and the deed conveyance from the homeowner to the purchaser (ie. the foreclosure rescue operator, straw buyer, etc.) is an equitable mortgage under F.S. 697.01.)

NJ Supremes Adopt Eight-Factor Standard For Equitable Mortgage Determination In Sale Leaseback Transactions; May Serve As Comprehensive, Practical Guide In Attempts To Undo Equity Stripping Foreclosure Rescue Scams

Reprinted from a recent Justia.com Opinion Summary:

• The issue this appeal presented for the New Jersey Supreme Court's review centered on an agreement for the sale of a residential property and a subsequent lease and repurchase agreement, specifically whether the transactions collectively gave rise to an equitable mortgage, violated consumer protection statutes, or contravened its decision in "In re Opinion No. 26 of the Committee on the Unauthorized Practice of Law," (139 N.J. 323 (1995)).
  
  In 2007, defendant Barbara Felton faced foreclosure proceedings with respect to her unfinished, uninhabitable home and the land on which it was situated. Felton and plaintiff Tahir Zaman, a licensed real estate agent, entered into a written contract for the sale of the property. A week later, at a closing in which neither party was represented by counsel, Felton and Zaman entered into two separate agreements: a lease agreement under which Felton became the lessee of the property, and an agreement that gave her the option to repurchase the property from Zaman at a substantially higher price than the price for which she sold it.
  
  For more than a year, Felton remained on the property, paying no rent. She did not exercise her right to repurchase. Zaman filed suit, claiming that he was the purchaser in an enforceable land sale agreement, and that he therefore was entitled to exclusive possession of the property and to damages. Felton asserted numerous counterclaims, alleging fraud, slander of title, violations of the Consumer Fraud Act (CFA), and violations of other federal and state consumer protection statutes. She claimed that the parties’ transactions collectively comprised an equitable mortgage and constituted a foreclosure scam, entitling her to relief under several theories. She further contended that the transactions were voidable by virtue of an alleged violation of "In re Opinion No. 26."
  
  A jury rendered a verdict in Zaman’s favor with respect to the question of whether Felton knowingly sold her property to him. The trial court subsequently conducted a bench trial and rejected Felton’s remaining claims, including her contention that the transactions gave rise to an equitable mortgage and her allegation premised upon In re Opinion No. 26. An Appellate Division panel affirmed the trial court’s judgment.
  
  The Supreme Court affirmed in part and reversed in part the Appellate Division’s determination. The Court affirmed the jury’s determination that Felton knowingly sold her property to Zaman. Furthermore, the Court affirmed the trial court and Appellate Division's decisions that Felton had no claim under the CFA, that this case did not implicate "In re Opinion No. 26," and that Felton’s remaining claims were properly dismissed.
  
  The Court reversed, however, the portion of the Appellate Division’s opinion that affirmed the trial court’s dismissal of Felton’s claim that the parties’ agreements constituted a single transaction that gave rise to an equitable mortgage, adopting an eight-factor standard for the determination of an equitable mortgage(1) set forth by the United States Bankruptcy Court in "O’Brien v. Cleveland," (423 B.R. 477 (Bankr. D.N.J. 2010)).
  
  The case was remanded to the trial court for application of that standard to this case, and, in the event that the trial court concludes that an equitable mortgage was created by the parties, for the adjudication of two of Felton’s statutory claims based on alleged violations of consumer lending laws, as well as several other claims not adjudicated by the trial court.

For the opinion summary and the court ruling, see Zaman v. Felton, Docket a-60-12 (N.J. Sept.9, 2014).

Filing a 'friend of the court' brief in support of the homeowner's position was Legal Services of New Jersey, a non-profit, public interest law firm that coordinates the statewide Legal Services system, which provides free legal assistance to low-income New Jerseyans for their civil legal problems.

For related posts, see:

• NJ Federal Judge Upholds Ruling Awarding $690K To Homeowner Screwed Out Of $116K In Sale Leaseback Scam; OK's Add'l $34K For Victims' Attorney Fees,
• Ruling That Sale Leaseback Was Equitable Mortgage Crucial To $294K Damages Award For Consumer Lending Law Violations In Equity Stripping Scam,
• State Consumer Fraud Act Yields Triple Damages Award For Homeowners In Bogus Sale Leaseback Equity Stripping Racket,
• Foreclosure Rescue Operator, Closing Attorney Found Jointly Liable For $690K+ In Bogus Sale Leaseback, Equity Stripping Ripoff,
• Failure To Allege Charging Of Excessive Interest In Sale Leaseback, Foreclosure Rescue Suit Fatal To Usury Claim,
• Court Hits Sale Leaseback Peddlers With $33K+ In Plaintiff's Legal Fees; Declines To Apply Contingent Risk Fee Enhancement, Opts Against Punitives,
• NJ An Unfriendly Place For Sale Leaseback Peddlers As Judge Slams Another Operator With $225K In Triple Damages, $50K+ In Homeowners' Legal Fees.

(1) The court's analysis of this issue follows:

In O'Brien, supra, the Bankruptcy Court scrutinized a residential sale that was conducted under the threat of imminent foreclosure, in which the parties agreed that the seller would remain in his home and buy the home back from the buyer in a series of payments over time. 423 B.R. at 483-86. It identified eight factors to assist trial judges in determining whether a given transaction gives rise to an equitable mortgage:

[(1)] Statements by the homeowner or representations by the purchaser indicating an intention that the homeowner continue ownership;

[(2)] A substantial disparity between the value received by the homeowner and the actual value of the property;

[(3)] Existence of an option to repurchase;

[(4)] The homeowner s continued possession of the property;

[(5)] The homeowner s continuing duty to bear ownership responsibilities, such as paying real estate taxes or performing property maintenance;

[(6)] Disparity in bargaining power and sophistication, including the homeowner's lack of representation by counsel;

[(7)] Evidence showing an irregular purchase process, including the fact that the property was not listed for sale or that the parties did not conduct an appraisal or investigate title;

[(8)] Financial distress of the homeowner, including the imminence of foreclosure and prior unsuccessful attempts to obtain loans. [Id. at 491.]

Under the O'Brien framework, the court considers not only the form of the transaction itself but circumstances that can motivate a party to disguise a mortgage secured by a property as a sale of land and indications that both parties intend the seller to retain the land notwithstanding the purported sale.

We concur with the District Court that the eight factors set forth in O Brien are useful and consistent with New Jersey equitable mortgage jurisprudence. Johnson, supra, 698 F. Supp. 2d at 470. We adopt the O'Brien factors as a comprehensive and practical standard to guide trial courts as they determine whether a particular transaction, or series of transactions, gives rise to an equitable mortgage.

We remand the matter to permit the trial court to make findings addressing each of the eight factors that comprise the O'Brien test.