Can a loan be too expensive?
That question, at the heart of a decade-old lawsuit over high-interest loans made by Orange County lender CashCall, is set to be taken up today by the California Supreme Court.
The court will hear oral arguments over whether California’s lending law allows courts to find that the interest rate on a loan can be so high that it is “unconscionable” and therefore illegal. It’s a sticky question that may require the justices to opine on what state legislators intended to do when they passed a lending-deregulation bill more than 30 years ago.
Lenders, consumer advocates and even California’s attorney general are watching the class-action case closely as the ruling could dramatically reshape the state’s lending market — or uphold a status quo in which loans with APRs topping 100% have surged in popularity.
A ruling that courts can find an interest rate is too high “would send shock waves through the financial-services sector,” said Catherine Brennan, a partner at law firm Hudson Cook who is monitoring but not involved in the case. “It would be a huge, big deal.”
The dispute centers on two parts of California’s lending law. One provision sets strict interest-rate limits on consumer loans up to $2,499 but none on larger loans. The Legislature removed those caps in 1985.
The other key part of the lending code, added by the same legislation that removed the rate caps, says courts can alter or strike loan terms deemed to be unconscionable.
Attorneys for CashCall argue in court filings that a finding of unconscionability should only apply to loan terms other than interest rates — and that if the Legislature wanted to restrict interest rates, it would not have scrapped the rate caps.
“The Legislature has chosen to exempt loans of $2,500 or more from any rate regulation,” the lender’s attorneys argue.
Why, they ask, would the Legislature deregulate interest rates, then allow a back door to allow courts to regulate them?
Attorneys for the plaintiffs, two Northern California borrowers, argue that the unconscionability language was added to address concerns that lenders would start charging unreasonable amounts of interest once rate caps were eliminated.
James Sturdevant, one of the plaintiffs’ attorneys, pointed to a letter sent in 1985 to Gov. George Deukmejian by the author of the rate-deregulation bill, state Sen. Rose Ann Vuich (R-Tulare).
Vuich wrote that the language was added to the legislation “to provide a remedy for excessive charges.”
CashCall, based in the city of Orange, was a pioneer in high-interest consumer lending. It was established by Ditech mortgage founder J. Paul Reddam, a Kentucky Derby-winning racehorse owner.
CashCall’s most popular product, a $2,600 loan, has over the years carried annual interest rates ranging from 79% to 179%.
One of the named plaintiffs, Eduardo De La Torre of Redwood City, was a student at UC Davis when he borrowed $2,600 from CashCall at an interest rate of 98%, according to the lawsuit. He would have had to pay back more than $9,000, a sum CashCall should have known De La Torre could not afford, according to the suit.
California Atty. Gen. Xavier Becerra and several consumer advocacy groups, including the National Assn. of Consumer Advocates and the Center for Responsible Lending, have sided with the plaintiffs, submitting briefs that argue interest rates can be unconscionable.
A filing from Becerra’s office references codes from ancient Rome and the Middle Ages that allowed contracts to be canceled because of unfair prices.
The Center for Responsible Lending and other groups contend in their briefs that courts should step in “where the market for consumer loans fails to produce socially tolerable terms” — and that CashCall’s loans, with high rates and payments stretched out for years, are simply not acceptable.
On the other side, CashCall is backed by the California Chamber of Commerce and several lending trade groups that say the Legislature, not the courts, should regulate interest rates and that a finding in favor of the plaintiffs could throw California’s lending market into disarray.
“Lenders … would be forced to scale back their credit offerings or exit the market altogether because of the uncertainty created,” lending trade groups wrote in their filing. “This is exactly the opposite of the Legislature’s statutory goal of ensuring access to credit.”
Indeed, a ruling in favor of the plaintiffs could give opponents of high-interest loans something they have failed to get in the Legislature. State lawmakers have authored bills that would bring back rate caps on larger loans, but the proposals have not made it through either chamber.
Brennan said that if courts can determine on a case-by-case basis what interest rate is acceptable, many lenders would simply stop lending in California.
She expects CashCall to prevail and said cases where loans or other contracts are deemed unconscionable generally involve specific problems, such as lenders not fully disclosing loan terms or taking advantage of customers who don’t or can’t understand those terms.
The lawsuit, aside from alleging that CashCall’s loans were unconscionable under state law, originally claimed the company violated federal bank-transfer and debt-collection laws.
The parties reached an $830,000 class-action settlement on those federal issues, but the question of interest rates remains. A federal judge in 2014 said determining CashCall’s rates were too high would require the court to “regulate economic policy,” something the judge was unwilling to do.
The borrowers appealed to the U.S. 9th Circuit, which in turn said it needed the California Supreme Court to determine whether interest rates can be unconscionably high under state law.
The stakes are great, as loans with rates topping 100% have become more common, the result of aggressive marketing, financial need and lenders’ willingness to approve loans to bad-credit borrowers after a short online application. Some lenders promise to deposit loan proceeds into a customer’s bank account in just a few hours.
In 2016, state-licensed lenders made more than 500,000 loans of between $2,500 and $5,000. Of those, more than half — about 300,000 — carried interest rates topping 100%. In 2006, lenders made just 42 loans in that size and interest-rate range.