Here is what the Moon case and its aftermath mean for the future of brokered loans in California.
In the Summer 2024 issue of Private Lender, we shared a brief history of usury law in California (the limitations on interest rates charged on business-purpose loans). Since writing that article, there have been exciting new developments in this space.
Although the fight in the courts had long since passed, the effort shifted to the legislature. We can now announce that these efforts succeeded: The bill has become law! Slated to take effect on Jan. 1, 2025, the law will impact your current and future loans.
Where We Were
Generally speaking, California caps the interest rate for all loans at 10%, though licensed lenders (typically California Finance Lenders, or CFLs) and licensed real estate brokers who are licensed through the California Department of Real Estate enjoy a complete exemption from this limitation.
It had long been thought that the usury exemption carried over to modifications or extensions of the original loans. However, through a series of court decisions, known as “In re Moon,” the broker exemption was limited to just the original term of the loan.
Where We Are
After these court decisions – but prior to the effective date of the new law – moving forward with an extension of a brokered loan requires a significant and thoughtful analysis as to whether any additional exemptions may apply. Loans made by a licensed DRE broker remain exempt, even when the loan is extended. Loans made by a licensed CFL lender remain exempt, even when the loan is extended.
The major change is now for loans arranged by a licensed DRE broker to a lender who is not otherwise licensed. These broker-arranged loans are still exempt from the usury law at the time they are made, but only for the original term of the loan. An extension of the time to pay, which includes formal modification agreements, forbearance agreements, or even less formal agreements to defer payment or to delay a foreclosure date, may all qualify as an extension or forbearance that may cause the loss of the exemption.
Certainly all new loans originated after Jan. 1, 2025 (when then new law takes effect), and any future modification of such loan will be subject to its provisions. However, it is impossible to truly answer the question as to what happens to existing loans originated before this date but may have modifications after it. The law does not provide for any retroactivity; thus, loan modifications that have already occurred would not be subject to the new law. However, new modifications on existing loans may be able to take advantage of the new law.
Consult an attorney for any specific scenario involving usury in California. Potential workarounds exist, and an experienced attorney can help guide you through which ones may apply to your situation.
Aftermath
Getting this bill passed was not the work of a single person or organization. A special thanks goes out to the California Mortgage Association, which pressed the legislators on this with us. We thank every one of our AAPL members, especially those who submitted letters, called their representatives, or donated to the cause. Grassroots efforts like this one are a fantastic example of what makes our organization great. AAPL has worked on this bill throughout its fast-tracked life in the legislature. It will continue to do so should there be a need.
RE: Letter in SUPPORT of Senate Bill 1146 –
Civil Code 1916.1 in Need of Modification in light of a Recent Court Ruling
Dear Governor Newsom,
We write to you today to express our strong support for your signing of Senate Bill 1146. This bill will save property owner’s ability to obtain loan modifications from their lenders ever since a series of poor judicial decisions narrowly interpreted the existing statute. We urge you to support and sign SB 1146 in order to right this wrong and clearly state the legislature’s purpose is to protect the availability of loan modifications. This bill passed through the consent calendar and has virtually unanimous support.
American Association of Private Lenders (AAPL) is an association of non-depository lending organizations who make non-consumer loans secured by real estate throughout the country. AAPL’s mission is to advocate on behalf of private lenders and set best practices for its members.
AAPL’s members primary focus is providing financing to real estate investors who seek to add value and density to existing housing stock, and the development of new housing stock. Real estate investors seek private lenders in these circumstances as most depository institutions are unable or unwilling to provide short-term financing options to real estate investors who may need to commit significant capital improving the property to make it inhabitable or otherwise increase the density of the property, typically requiring significant construction. AAPL members are quite active in the state of California with many members headquartered in the state and more than 16,000 mortgage loan transactions by private lenders in 2023 totaling more than 5 billion dollars in loans provided to residents of the State.
Article XV of the California Constitution generally limits the interest rate for loans to 10% per annum. An exemption in the Constitution is given to any loan secured by real property which is made or arranged by a licensed California real estate broker; further codified and expanded upon under California Civil Code 1916.1. This constitutional and statutory exemption is critical, particularly in today’s high interest rate environment as private lenders take on significant risk when providing financing for construction loans. Lightning Docs, LLC a loan document system for private lenders, ran an analysis of 3987 private loans ($2.4BN of loans) in California from January 1, 2023 to March 31, 2024 with an average interest rate of 11.08%.
However, when the legislature amended this statute in 1985, they made an odd but unique distinction between arranging a new loan and modifying or forbearing an existing loan. Recently, a 9th Circuit ruling in the case of In Re Moon reviewed this statute. The case involved a loan which was arranged by a licensed real estate broker and therefore exempt from usury. The lender subsequently modified the loan and reduced the interest rate. The court determined that the modification which reduced the interest rate made the loan usurious.
The Court’s decision is based on Civil Code Section 1916.1 which states in pertinent part: “…Article XV of the California Constitution shall not apply to any loan or forbearance made or arranged by any person licensed as a real estate broker by the State of California, and secured, directly or collaterally, in whole or in part by liens on real property. For purposes of this section, a loan or forbearance is arranged by a person licensed as a real estate broker when the broker:…(1) acts for compensation or in expectation of compensation for soliciting, negotiating, or arranging the loan for another… (3) arranges or negotiates for another a forbearance, extension, or refinancing of any loan secured by real property in connection with a past transaction in which the broker had acted for compensation or in expectation of compensation for selling, buying, … of real property…”
The Court read the first subdivision as pertaining only to “loans” and thus not forbearances or extensions, and the only time a forbearance or extension would be exempt from, the purchase and sale broker has nothing to do with the financing of the property. Moreover, even if they did, it does not usury would be when it was arranged by a licensed broker who was involved in the purchase or sale of the property. As a preliminary matter it doesn’t make any sense to require the original broker to the purchase or sale to be involved as that person may have retired, deceased or otherwise unable or unwilling to be involved.
We believe the intent of the legislature was to create a usury exemption for any loan, extension, or forbearance which is arranged by a licensed real estate broker. Unfortunately the existing language has proven to be ambiguous. Accordingly, we agree that the simple amendment to the statute through Senate Bill 1146 would match with the California Constitution and the actual intent of the legislature.
The effect of these court rulings has sent shockwaves through the community. Until and unless Civil Code 1916.1 is modified, lenders are unfortunately in a position where they are no longer able to modify their loans without risking making them usurious. Mortgage lenders should be encouraged to modify and otherwise forbear on loan obligations as the alternative would be to foreclose on their borrowers which is a lose-lose for the borrower and the lender which cannot reasonably be the intent of the legislature.
Sincerely,
Eddie Wilson, Chairman, AAPL; Linda Hyde, President, AAPL; Nema Daghbandan, AAPL General Counsel, Geraci LLP
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