A recent 5th Circuit case, Achee Holdings, LLC v. Silver Hill Financial, LLC, Slip Copy, 2009 WL 2610797 (5th Cir.), Aug. 26, 2009 (not published in Federal Reporter), provides an interesting discussion of usury law in Texas and its application to a fee designated in the relevant loan documents as a "Lockout Fee."
Briefly, the facts are: Achee executed an adjustable rate promissory note (the "Note") in favor of Silver Hill. The Note provided for two prepayment penalties for prepayment of the principal during the first 36 months of the loan period (the "Lockout Period"): (1) an amount equal to the interest that would have accrued on the unpaid principal balance during the Lockout Period (labeled the "Lockout Fee") and (2) an amount equal to 5% of the then outstanding principal balance (labeled the "Prepayment Consideration"). During the Lockout Period, Achee sought to prepay the loan. Achee refused to pay the Lockout Fee and filed this lawsuit alleging that the Lockout Fee was disguised interest that exceeded the allowable amount under Texas usury law. The trial court dismissed the suit for failure to state a claim and the 5th Circuit, hearing the case on Achee's appeal, affirmed.
The Court's opinion summarized the essential elements of a usurious transaction as (1) a loan of money, (2) an absolute obligation that the principal be repaid, and (3) the exaction from the borrower of a greater compensation than the amount allowed by law for the use of money by the borrower. Under Texas Finance Code sec. 301.022(a)(4), "interest" is defined as "compensation for the use, forbearance, or detention of money . . . [but] does not include compensation or other amounts that . . . are permitted to be contracted for, charged, or received in addition to interest[.]" Where a contract grants the borrower a prepayment right, Texas courts have held that a prepayment penalty is not interest because it is not compensation for the use, forbearance, or detention of money, but is instead "a charge for the option or privilege of prepayment." This concept is codified at Texas Finance Code sec 306.005: "a creditor and an obligor may agree to a prepayment premium . . . whether payable in the event of voluntary prepayment . . . or other cause that involves premature termination of the loan, and those amounts do not constitute interest."
Lenders can, however, violate usury law by charging fees that constitute "disguised interest." Whether a particular fee is disguised interest depends on the substance of the transaction, not how the parties label the fee. Specifically, a fee will not be considered interest if it is not a charge for the use, forbearance, or detention of money, but a fee might be considered interest if it is not supported by separate and additional consideration.
Achee contended that the Lockout Fee was disguised interest and therefore usurious. The 5th Circuit disagreed. Though the interest rate on the loan was used as part of the formula for calculating the Lockout Fee, the Court found that the substanceof the transaction indicated clearly that the Lockout Fee was a prepayment penalty: The Note granted Achee the option of paying the loan off early (and also paying the Lockout Fee) in exchange for avoiding the 27 years of interest that otherwise would have accrued over the remaining loan term. In other words, the Lockout Fee acted as consideration for the privilege of paying the loan off during the first three years and thereby avoiding further interest.
The Court noted that the fact that the Note included two types of prepayment penalties, one of which applied only to a prepayment during the Lockout Period, didn't change the fact that the Lockout Fee operated, in substance, as a penalty for very early prepayment. Also relevant to the Court's analysis was the fact that Achee could avoid the Lockout Fee entirely by waiting until after the Lockout Period expired to pay off the loan (the Court cited its holding in an earlier case where this type of fact had been recognized as the rationale for the rule that prepayment penalties are not interest).
