Over the last few years, the California courts have made two important rulings that could have significant implications for your private lending practices. These rulings relate to charging default interest and handling loan modifications or extensions that exceed California’s usury rate.

1. Default Interest Charges in California

 (Honchariw v. FJM Private Mortgage Fund Decision 83 Cal. App 5th 893)

On September 29, 2022, the California 1st District Court of Appeals issued an important decision that prohibits lenders from charging default interest against the principal balance of any loan, regardless of the loan’s purpose. FJM won the arbitration ruling, but Honchariw appealed the denial to the California Court of Appeals, resulting in the decision. Although Geraci LLP and Wright, Finlay, & Zak petitioned the California Supreme Court to review the case, the California Supreme Court denied the review on December 21, 2022.

The denial of the review means that the Honchariw decision is final. Therefore, California lenders should review and update their existing loan documents to ensure their terms conform to the ruling. Default interest is permitted only if the lender defaulted the borrower for maturity. Default Interest is otherwise prohibited for all other defaults including non-payment. If a lender still chooses to asses a default interest charge, they should confer with counsel before proceeding. 

Key Takeaways:

• Proportionality: Default interest must correlate with the actual costs or losses incurred due to the borrower’s default.

• Documentation: It is crucial to document and justify the basis for the default interest rate applied.

• Transparency: Ensure that all terms related to default interest are clearly stated in the loan agreement and communicated to the borrower upfront.

2. Loan Modifications and Extension Above Usury Rates

(Milestone Financial, LLC, v. Moon 648 B.R. 73 [B.A.P. 9th Cir. 2023)

On March 24, 2024, the 9th Circuit Court of Appeals upheld the Bankruptcy Court’s ruling that loan modifications or extensions resulting in an interest rate exceeding California’s usury limits violate the law. The court emphasized that any modifications or extensions to existing loans must comply with California’s usury laws, which cap the maximum allowable interest rate for non-exempt lenders.

Lenders can extend their own loans by incorporating a provision for a pre-negotiated extension into their original loan documents.

Key Takeaways:

• Compliance with Usury Laws: Any changes to the loan terms, including extensions or modifications, must adhere to California’s usury cap, which is typically 10% per annum for non-exempt loans.

• Exemptions: Be aware of and verify whether your loan qualifies for any exemptions under California usury laws.

• Due Diligence: Conduct thorough due diligence and legal review before approving any loan modifications or extensions to ensure compliance with usury regulations.

Action Steps:

1. Review and Update Loan Agreements: Assess your current loan agreements and ensure they comply with these rulings. Update any terms related to default interest and loan modifications or extensions accordingly.

2. Seek Legal Counsel: Consider consulting with legal counsel to understand better how these rulings may impact your specific lending practices and to ensure full compliance.

3. Awareness: Inform your team about these changes and provide training on your lending procedures’ implications and necessary adjustments.

Staying informed and compliant with legal requirements is crucial for the sustainability and legality of your private lending business, even if these cases only affect loans originating in California.

Thank you for your attention to these important legal updates.