BILL ANALYSIS
SENATE JUDICIARY COMMITTEE
Senator Joseph L. Dunn, Chair
2005-2006 Regular Session
SB 627 S
Senator Ackerman B
As Amended April 28, 2005
Hearing Date: May 3, 2005 6
Corporations Code 2
GMO:rm 7
SUBJECT
Usury Exemption
DESCRIPTION
This bill would restore application of the usury law to
real estate loans. The bill would carve out, from the
statutory exemptions to the constitutional prohibition
against usury, a debt secured, in whole or in part, by real
property owned or leased by the borrower, provided the
primary purpose for the borrowing is to finance the
acquisition, ownership, development, leasing or sale of the
property. This carve out from the exemption would not
apply to institutional investors, as defined.
BACKGROUND
The California Constitution prohibits usury, but exempts
certain transactions and lenders from this provision. The
Constitution also allows the Legislature to exempt
additional transactions or classes of persons. The
Corporate Securities Act of 1968, as amended by AB 244
(Ackerman, Chapter 468, Statutes of 2000), exempts certain
evidences of indebtedness issued by an entity with assets
of more than $2 million, and certain evidences of
indebtedness of $300,000 or more under specified
circumstances.
CHANGES TO EXISTING LAW
(more)
SB 627 (Ackerman)
Page 2
The California Constitution prohibits an interest rate of
more than 7 percent per annum for the loan or forbearance
of payment for any money, goods, things in action, or
accounts on demand, but allows competent parties to: (1)
contract for consumer goods (e.g., for personal, family or
household purposes) at interest rates up to 10 percent per
annum; and (2) contract for other than consumer goods at a
rate not exceeding the higher of 10 percent per annum or 5
percent per annum plus the prevailing Federal Reserve
interest rate, as specified. This is known as the usury
provision of the Constitution. [Section 1, Article XV,
California Constitution.]
The usury provision allows exemptions for specified
contracts, such as loans made by a building and loan
association, by an industrial loan company, by a credit
union, by a licensed pawn broker or personal property
broker, by a licensed real estate broker and secured by a
lien on real property, by a bank, by a nonprofit
cooperative agricultural association that loans money or
assists a member in obtaining a loan under specified
conditions, or by a successor in interest to any loan
already exempted, and allows the Legislature to create, by
statute, other exemptions.
Existing law exempts from the usury provision evidences of
indebtedness issued or guaranteed by an entity with more
than two million dollars ($2,000,000) in assets, provided
the entity has a financial statement meeting this condition
within 90 days before the issuance of the indebtedness that
was prepared according to generally accepted principles or
in accordance with the rules of the Securities and Exchange
Commission. [Corporations Code Section 25118 (a).]
Existing law separately exempts from the usury provision
evidences of indebtedness (and the holders thereof) that
aggregate $300,000 or more or were purchased at an
aggregate discount price of $300,000 or more, or were
issued pursuant to a written commitment for the lending of
at least $300,000 or the provision of a line of credit of
$300,000 or more. [Corp. Code Sec. 25118(b).]
Existing law specifies that the exemptions described above
do not exempt a person from application of the California
Finance Lenders Law. [Corporations Code Section 25118(h).]
SB 627 (Ackerman)
Page 3
This bill would make the above exemptions inapplicable to a
debt secured by real property owned or leased by a
borrower, where the primary purpose of the extension of
credit is to finance the acquisition, ownership,
development, sale or leasing of that real property or any
improvements on it.
This bill would make this exception to the exemption
available only to non-institutional investors.
COMMENT
1. Stated need for the bill
When Section 25118 was enacted, the legislation specified
its intent to affect only commercial loans. That bill
also declared its intent to not affect any other
provision of law that requires any person involved in the
(commercial) transaction from applicable licensing
requirements that protect parties from unfair, unlawful,
or deceptive acts or practices, or that affect the
availability of the exemption to a successor in interest
of the originating lender. [Section 1 of AB 244
(Ackerman), Chapter 468, Statutes of 2000.]
According to the author, Corporations Code Sec. 25118 was
written to enable small and start-up companies to obtain
short-term debt financing, including principally bridge
loans, without enduring the time and expense to obtain a
permit to sell a security under Corporations Code Section
25113 and to protect a lender against the state
Constitution's prohibition on usury.
Instead, the author states, this exemption to the usury
provision under Section 25118 is being used for long-term
real estate development transactions without compliance
with the state's Finance Lenders Law or Real Estate Law.
Rather than using the same complicated approach taken
last year in SB 1406, this bill would simply except from
the exemption provided in Section 25118 those loans that
are secured by real property, when the loan is for the
acquisition, development, or lease of the property. This
SB 627 (Ackerman)
Page 4
would allow loans secured by the real property but for
other business uses to be made without being held to the
interest rate limitations established in Section 1,
Article XV of the Constitution for purchases of other
than personal, family, or household goods. However,
another limiting provision would make these
higher-than-permissible interest rate loans applicable
only to institutional investors.
2. Exceptions to the exemption: debt issued by
individuals, revocable trust, partnerships, and straight
commercial real estate loans
When Section 25118 was enacted, there was considerable
debate over whether or not the exemption created would
constitute "legal loan sharking." This concern was
mollified by assurances that the exemption would only
apply where the transaction involved business persons who
are affiliated or who had "a preexisting personal or
business relationship" and the "capacity to protect their
own interests in connection with the transaction." [Corp.
Code Sec. 25118(f)(1) and (2).] Section 25118 applies
only to commercial transactions, and not to contracts for
the purchase of personal or household goods or services.
Unless qualified under this exemption, an issuer of
evidence of indebtedness (i.e., promissory note,
debenture, bond, other types of securitized paper) must
obtain a permit to sell a security or exempt itself under
Section 25113 or be exempt from the usury provision under
other exemptions (see Changes to Existing Law for listing
of other exemptions).
Section 25118 does not apply to an indebtedness issued or
guaranteed by an individual, a revocable trust having one
or more individuals as trustors, or a partnership in
which, at the time of issuance, one or more individuals
are general partners. The exemption also does not apply
to a transaction subject to the seven or ten percent
limitation on permissible interest rates specified in
Article XV of the Constitution for purchases of personal,
family or household goods or the higher interest rate
established for non-household, family or personal goods
purchases.
SB 627 (Ackerman)
Page 5
This bill would add to the transactions to which the
exemption under Sec. 25118 would not apply. These are
transactions where an evidence of indebtedness (note,
promissory note, etc.) is secured, in whole or in part,
by real property owned by the borrower, and the money is
borrowed for the purpose of financing the acquisition,
development, leasing, or sale of the real property. In
this case, such a loan would be subject to an interest
rate equal to the higher of (a) 10% per annum or (b) five
percent per annum plus the rate prevailing on the 25th
day of the month preceding the earlier of either the date
of execution of the contract to make the loan or the date
of making the loan established by the Federal Reserve
Bank of San Francisco as that rate is amended from time
to time. These rates are articulated in Article XV,
Section 1 (first sentence).
Thus, those who would loan money against real property
for the purpose of the acquisition of the property, or
its development, sale or lease, may charge a maximum rate
as allowed by Article XV. This would take care of the
concern, expressed over the last couple of years by
proponents of SB 627 and last year's SB 1406, that real
estate commercial loans were being made at very high
interest rates by venture capital groups that do not
conform to the California Finance Lenders Law. If the
venture capitalists are not complying with the finance
lenders law, their commercial real estate transactions
would be limited to interest rates that do not exceed the
permissible rate under the Constitution.
3. Exemption would remain for real estate loans where
proceeds are used for other business purposes
Under this bill, a commercial real estate loan between
two more or less equal parties who have had a preexisting
relationship may be made at interest rates higher than
the limits established in the anti-usury provisions of
the constitution, if the loan is made for business
purposes other than the financing of the purchase,
development, sale, or lease of the real estate property
itself.
So, for example, if the owner of a large commercial
property puts up the property as collateral to borrow $1
SB 627 (Ackerman)
Page 6
million from his rich colleague's company for the purpose
of buying a stake in an upstart company, and the loan is
at a 35% annual interest rate, the owner would not be
able to assert a claim that the interest rate should have
been limited to (for example, 17%) which is the maximum
allowable under the constitutional ban on usurious rates,
when the upstart company goes bankrupt before it even
gets started. The rich colleague's company should be
able to take recourse against the property owned, if the
borrower does not pay the loan as agreed upon.
However, under this bill, this would not work if the rich
colleague's company is an institutional investor as
described in Corporations Code Sec. 25102(i)(1). These
are pensions or profit-sharing trusts, companies
registered under the Investment Company Act of 1940,
banks, savings and loan associations, trust companies,
and insurance companies. These institutional investors,
because they would be covered by finance lending laws,
would be subject to those laws and may only be able to
charge interest rates higher than allowed under the
anti-usury provision if they meet specified requirements.
Otherwise, they would be held to the limitations of
interest rates established in the Constitution.
Support: None Known
Opposition: None Known
HISTORY
Source: KPA Realty LLC
Related Pending Legislation: None Known
Prior Legislation: SB 1406 (Ackerman, 2004). Vetoed.
AB 2969 (Florez, Ch. 964, Stats. 2002)
modified requirements regarding financial
statements of borrowers with $2 million in
assets.
AB 244 (Ackerman, Ch. 468, Stats. 2000)
enacted Corporations Code Section 25118.
SB 627 (Ackerman)
Page 7
**************