Last Monday, the California Supreme Court ruled that interest rates on loans over $2,500 could be deemed ‘unconscionable’ even if usury laws permit them. In De La Torre v. CashCall, the court was asked to resolve an ambiguity in the California Finance Lender’s Law—whether the interest rate on consumer loans of $2,500 or more render the loans unconscionable under section 22302 of the Financial Code. The court answered ‘yes.’
Although California sets interest rate caps only on consumer loans less than $2,500, we do not glean from the statute setting those rates—section 22303 of the Financial Code—the implication that a court may never declare unconscionable an interest rate on a loan of $2,500 or more.
The case is relatively straightforward. Section 22303 of the Financial Code deregulated interest rates so that the market could set rates above $2,500. But at the same time, Section 22302 was added to allow all loans to be considered unconscionable under the appropriate circumstances. The legislative history points to a trade-off, freeing larger loans from usury laws while maintaining an unconscionability standard for consumer protection. While one can rightly quibble with the wisdom of that policy, the court found no conflicting issue in the statute itself, bound by what can simply be considered an ill-conceived law.
The implications of the ruling, however, are great, introducing an enormous amount of uncertainty into the California lending market, with judges now being asked to determine the point at which a loan contract becomes unconscionable. The California Supreme Court recognized the difficulty with this requirement. “We recognize how daunting it can be to pinpoint the precise threshold separating a merely burdensome interest rate from an unconscionable one… That responsibility is one courts must pursue with caution.” The task is daunting indeed. At what point does a high interest rate become so high that it is deemed unconscionable? Does it depend on the level of competition in the marketplace, the loan’s term structure or underwriting, the marketing practices employed, or all of the above? All these factors are likely to be heavily litigated without clarification from the California legislature. And of course, this will mean that California judges will be writing de facto economic policy in the process.
Although the Court affirmed that they can determine whether a loan can be unconscionable from its interest rate, it cast limited judgement on whether courts should do so. The court stressed that any analysis must be "highly dependent on context" and "flexible" when determining whether a particular rate was “overly harsh” or “unduly oppressive.” It also warned lower courts to be wary of "across-the-board imposition of a cap on interest rates" from their decisions. The burden of proof in proving plaintiff claims is also high, given they would have to prove that the lender operated in a noncompetitive market and therefore charged exorbitant interest rates that reflect rents instead of a genuine assessment of risk.
But without assurance that high-risk installment loans won’t be under attack for their associated high interest rates, it can be expected that there will be serious disruption for state-licensed lenders. For example, years of litigation has lead CashCall itself to stop making personal loans. This means that marginal consumers, whose risk profiles require high-interest rates, will be pushed into worse and worse financial options, hardly the aim of the legislatures who crafted the lending laws.
To maintain financial stability and access to credit, the California legislature needs to fix the flaw in their lending laws highlighted by De La Torre. Simply repealing Section 22302 would solve the issue, as would amending the law to clarify that the interest rates may not be found unconscionable.