A recent Texas state court decision highlights the many challenges a defendant may face when alleging usury as a defense to a breach of contract action. In the case, the defendant argued that the 30% interest rate the plaintiff charged pursuant to a promissory note exceeded Texas’ usury code. As a result, the defendant argued, the note was void or voidable. The court rejected the defendant’s argument. In its decision, the court explained a number of legal principles that significantly limit the breadth of a usury defense.
- “Usury statutes are penal in nature and are to be strictly construed.”
This principle narrows the potential scope of a usury defense. Courts are generally reluctant to reform otherwise valid agreements. Therefore, if a contract is susceptible to multiple interpretations a court must adopt the construction that would render the contract enforceable.
2. “[The] party making a claim of usury has the burden of proof.”
A party alleging a usury violation must prove three elements: (i) a loan of money; (ii) an absolute obligation to repay the principal, and (iii) the exaction of a greater rate of interest than allowed by law for the use of the money by the borrower.
3. A valid savings clause will automatically limit the amount of interest that a creditor is entitled to collect to an amount within the limits of the applicable usury law.
A typical savings clause will provide that in the event that a provision of a contract is found by a court to be invalid, illegal or unenforceable then the contract shall be construed as if the provision had not been included in the contract. The effect of a valid savings clause is to strip an otherwise usurious rate from the agreement and replace it with a permissible rate.
4. Violations of the usury statute void the usurious interest, not the underlying obligation.
A note that carries an interest rate that exceeds the applicable usury cap is still enforceable even though the rate charged is illegal. Therefore, while a court will not permit a creditor to collect usurious interest, the creditor may still recover principal and any allowable interest.
After reviewing these principles, the Texas court found that even though the promissory note at issue charged an interest rate that was double Texas’ usury cap, the creditor was still entitled to recover principal and to enforce its related security interest.
Franch v. HP Locate, LLC, 2015 U.S. Dist. LEXIS 154350 (N.D. Tex. Nov. 16, 2015)