Don't Bet the Business

There are laws in Michigan that prohibit the charging of excessive contractual interest rates.  These are called “usury laws.” The charging of excessive interest is not only prohibited under Michigan common law, in certain circumstances it is a crime.

A typical commercial mortgage loan is a good example. Assume that a borrower signs a promissory note to repay a $5 million mortgage loan over 10 years. The note provides that during the loan period the lender will charge interest at the rate of 18%, but if other periodic charges are considered the interest rate actually exceeds 25%. The note also contains a provision stating that it cannot be construed to require an excessive or illegal interest rate. In fact, the note’s “usury savings clause” states that only the highest, legally permitted interest rate will apply and be collected.  

This type of savings clause historically was relied upon to insulate a lender from usury liability; it also protected the loan from a legal challenge that it is legally unenforceable. That was then, but the rules have changed.

In a recent decision, the Michigan Supreme Court ruled that usury savings clauses are ineffective if a promissory note facially requires a borrower to pay what amounts to a usurious interest rate. In simple terms, the Supreme Court’s ruling requires lenders to know the law and to apply it when charging contractual interest, fees and other loan charges that could be construed as other interest. 

Usury is commonly defined as charging and receiving an amount greater than allowed by law. Michigan has codified its usury laws at MCL 438.31 and MCL 438.32. Usury is not defined by a single interest rate, and the highest allowable rate has changed over time. Currently, the civil usury rate is 5% or 7% if stipulated in writing. See MCL 438.31. However, higher rates are permitted under MCL 438.31c for certain types of loans. The criminal usury rate is 25%. See MCL 438.41.

A lender found to have charged a civilly usurious interest rate is prohibited from collecting any interest, fees, attorneys' fees, or cost and, in fact, in a lawsuit the borrower is able to recover its attorney fees and costs from the lender.  MCL 438.32. One found guilty of criminal usury “may be imprisoned for a term not to exceed 5 years or fined not more than $10,000.00, or both.” MCL 438.41.

To avoid these penalties, and essentially insulate oneself from Michigan’s usury laws, lenders typically include in their loan documents “savings clauses” providing that if the note is found to require a usurious interest rate it should be construed as requiring only the highest legally permissible rate. 

Savings clauses historically worked, but no longer.  In Soaring Pine Capital, the Michigan Supreme Court held that “usury savings clauses are unenforceable when they nullify the statutory remedy for usury, thereby relieving lenders of their duty to ensure that loans are not usurious.”

The Supreme Court did not render all usury savings clauses unenforceable. The high court’s ruling was directed at “facially usurious” loans.  Indeed, the Supreme Court recognized that legitimate uses for usury savings clauses remain, particularly “where the transaction is not clearly usurious at the outset but only becomes usurious upon the happening of a future contingency” that is outside of the parties’ control. The scope of this exception was left undefined for now.

The overall import of the Supreme Court’s ruling, and the effect it may have on how lenders charge interest rates to their borrowers, is not yet known. What is certain, however, is that in Michigan the usury laws have changed and lenders will need to catch up.