August 29, 2018

Capping Conscionability – Considerations for Lenders after CashCall

4 min

Lenders were reminded they may need to reconsider their interest rates when a lending law states that it does not apply to loans above a specified amount.

California's highest court handed down a unanimous ruling that has rattled the subprime loan market. In Eduardo De La Torre, et al. v. CashCall, Inc., the California Supreme Court held an interest rate on consumer loans of $2,500 or more may be deemed "unconscionable" and, therefore, illegal under California law. Although the California Finance Code sets interest rate caps only on consumer loans less than $2,500, the Court did not accept CashCall's position that the statute setting those rates implies that a court may never declare unconscionable an interest rate on a loan of $2,500 or more.

High-risk borrowers may justify high rates, but…

The Court's message was clear: "[C]ourts have a responsibility to guard against consumer loan provisions with unduly oppressive terms." But the Court also noted, "That responsibility is one courts must pursue with caution. Unsecured loans made to high-risk borrowers often justify high rates. Both consumers' acceptance of such rates, as well as restrictions on them, may trigger unintended consequences."

The California Supreme Court was asked to interpret the state law by the Ninth Circuit Court of Appeals from an appeal of a consumer class action against CashCall. Commencing in 2008, the class action filed in federal court alleges CashCall violated California's Unfair Competition Law (Bus. & Prof. Code, § 17200) by offering $2,600 unsecured loans payable over a 42-month period, carrying an annual percentage rate of 96-135%. The plaintiffs claim CashCall violated the unlawful prong of the UCL by ignoring the Financial Code's prohibition on unconscionable loans. The plaintiffs seek restitution and injunctive relief for Californians who took out the loans between 2000 and 2011.

What's next for the CashCall loans?

The Court stopped short of finding these loans unconscionable, and instead left the determination to the lower courts and legislature. In declining to draw a bright line for a permissible interest rate, the Court noted that unconscionability is a "flexible standard" that is "context-specific" and "malleable." The Court noted the Finance Code refers to "Civil Code section 1670.5… a verbatim enactment of Section 2-302 of the Uniform Commercial Code (UCC) … [that] made unconscionability a doctrine applicable to all contracts."

UCC Section 2-302 provides:

(1) If the court as a matter of law finds the contract or any clause of the contract to have been unconscionable at the time it was made the court may refuse to enforce the contract, or it may enforce the remainder of the contract without the unconscionable clause, or it may so limit the application of any unconscionable clause as to avoid any unconscionable result.

(2) When it is claimed or appears to the court that the contract or any clause thereof may be unconscionable the parties shall be afforded a reasonable opportunity to present evidence as to its commercial setting, purpose and effect to aid the court in making the determination.

What does this mean for lenders with loans in other states?

All 50 states and the territories have adopted the UCC, and many have directly imported Section 2-302 to apply to all contracts made in the state. In addition to California, there are at least a handful of states that do not impose interest rate caps on certain loans and that have directly incorporated the UCC's unconscionability prohibition into their lending statutes. As in California, the unconscionability prohibition would permit a borrower to argue that in those states a loan provision or contract in its entirety is invalid on the basis of unconscionability.

The CashCall decision applies only to California loans, and the true extent of its consequences both in and outside of California will not come to light until the lower courts determine whether the loans in question were indeed unconscionable. Nevertheless, subprime personal lenders should closely monitor its development, because it may offer guidance and analysis for California loans, and for other state courts interpreting statutory frameworks like California's to come to a similar decision regarding loans not subject to statutory interest caps.