What is the Rate of Interest on Unpaid Promissory Note?
In the recent decision in Soleimany v. Narimanzadeh, the appellate court reviewed the rate of interest that applies for the breach of a promissory note.
Under California law, if a promissory note evidencing a loan stipulates a usurious rate of interest—that is, a rate in violation of the limits set by article XV, section 1 of the California Constitution—the interest provision is void, and the principal sum is deemed due at maturity of the note without interest (meaning that any interest paid is applied against the principal so as to reduce the principal obligation owed).
However, if any of the principal amount is unpaid at the date of maturity, the lender is entitled to damages in the form of prejudgment interest on any such unpaid amount from the date of maturity of the loan to the date of judgment.
The appropriate rate of prejudgment interest is determined by the law applicable to contracts that do not stipulate a legal rate of interest.
If a contract stipulates a legal rate of interest, that rate is the applicable prejudgment rate. (Civ. Code, § 3289(a).)
In 2008, defendant Mostafa Narimanzadeh borrowed $350,000 from plaintiffs Kiumars and Shanaz “Suzy” Soleimany (husband and wife).
The loan was documented by a promissory note which was secured by a deed of trust on real property belonging to defendant Narimanzadeh.
In 2009, defendant Fariba Atighehchi borrowed $150,000 from plaintiff Shanaz Soleimany. The loan was documented by a promissory note signed by defendant Atighehchi; the note was not secured by a deed of trust on real property.
In a court trial on plaintiffs’ action against defendants for breach of the obligation to repay the loans, the trial court voided the usurious interest rate on both notes and deemed the principal sum of the notes due at maturity.
Any interest paid by defendants up to maturity would be applied as a credit against the principal of the loans to determine if, in fact, any principal remained due at the date of maturity.
Civil Code section 3289(b) provides that if a contract “entered into after January 1, 1986, does not stipulate a legal rate of interest, the obligation shall bear interest at a rate of 10 percent per annum after a breach.”
But subdivision (b) excludes from its coverage any “note secured by a deed of trust on real property.”
For the 2009 loan, that was not secured by a deed of trust on real property, the trial court fixed the prejudgment interest rate on any unpaid principal at 10 percent.
On the 2008 loan, however, the trial court ruled that Civil Code section 3289(b) did not apply, because the promissory note was secured by a deed of trust on real property, and therefore plaintiffs were entitled to no prejudgment interest on any principal due at the date of maturity on that loan.
Based on the calculations compelled by these rulings, the evidence showed that defendants had in fact overpaid the loans.
Therefore, the court concluded that plaintiffs had not proved any damages, granted defendants’ motion for judgment, and awarded attorney fees and costs to the defendants as prevailing parties.
In the appeal by plaintiffs, the appellate court held that even though Civil Code section 3289(b) does not apply to the 2008 loan because it was secured by a deed of trust on real property, the plaintiffs were nonetheless entitled to prejudgment interest on the unpaid principal at the date of maturity at the rate of 7 percent, the default rate of prejudgment interest provided in article XV, section 1 of the California Constitution, which applies except when a statute provides otherwise.
Therefore, the judgment was reversed in part and the matter was remanded to the trial court for further proceedings.
The trial court on remand was ordered to conduct further trial proceedings on plaintiffs’ potential damages, in which the parties may present evidence as to whether, using a prejudgment interest rate of 7 percent against any amounts of unpaid principal at the date of maturity, plaintiffs incurred any damages with respect to the 2008 loan.
In light of such evidence, the trial court should enter a new judgment as appropriate.
Further, in light of the new judgment, the court shall reconsider as appropriate which parties (if any) are prevailing parties, and the amount of attorney fees and costs to which any such prevailing parties are entitled.
The relevant factual and procedural background in this case was undisputed.
In 2008, defendant Narimanzadeh borrowed $350,000 from plaintiffs Kiumars and Shanaz Soleimany. The loan was documented by a promissory note secured by a deed of trust on defendant Narimanzadeh’s specified real property located on Chantilly Road in Los Angeles.
According to the note, defendant Narimanzadeh promised to repay the principal amount, plus interest at a rate of 16 percent per annum, by March 1, 2009.
In 2009, defendant Atighehchi borrowed $150,000 from plaintiff Shanaz Soleimany. The loan was documented by a promissory note, in which defendant Atighehchi agreed to repay the principal amount, plus interest at a rate of 16 percent per annum.
It was not secured by a deed of trust on real property.
Defendants failed to pay off their respective loans by the 2009 dates of maturity. However, they continued to make payments on the loans through October 30, 2015, and at some point (the record is not clear), started paying interest at the rate of 10 percent (instead of 16 percent).
The parties agreed defendants paid plaintiffs $601,568.96 but did not distinguish between the two loans.
In 2017, plaintiffs filed the operative, first amended complaint against defendants.
As to the 2008 loan, plaintiffs alleged breach of written loan agreement against defendant Narimanzadeh, and sought judicial foreclosure against Narimanzadeh’s real property securing the loan.
As to the 2009 loan, plaintiffs alleged breach of written loan agreement against defendant Atighehchi.
Defendants conceded breach of the written loan agreements by not paying the principal on the loans by the date of maturity, but raised as an affirmative defense that the 16 percent interest rate on the loans was void as usurious.
Pursuant to the parties’ stipulation, the matter was tried to the court in two phases. In the first phase, the court considered defendants’ usury affirmative defense, and, assuming the 16 percent interest rate was usurious, the rate of prejudgment interest, if any, the law would apply to any unpaid principal on the loans.
The court found that the interest rate of 16 percent on both loans was void as usurious, exceeding the 10 percent maximum permissible rate under Article XV, section 1 of the California Constitution.
Therefore, the loans were to be treated as if they did not specify an interest rate, and the principal (without such interest) was deemed due at maturity. Any usurious interest paid on the notes was to be applied against the principal to determine if any principal amounts were still unpaid.
With respect to the issue of prejudgment interest on the principal due to which the law entitled plaintiffs, the court applied Civil Code section 3289(b) to the 2009 loan, as it was not secured by a deed of trust on real property.
Thus, the court determined that prejudgment interest at the legal rate of 10 percent would be due on the unpaid principal at the date of maturity.
However, because Civil Code section 3289(b) did not apply to the 2008 loan, which was secured by a deed of trust on defendant Narimanzadeh’s real property, the court ruled that plaintiffs were not entitled to prejudgment interest on that loan.
Thereafter, the court conducted the second phase of the trial to determine whether, based on its ruling in the first phase, plaintiffs were owed any sums as damages in addition to what defendants had already paid on their respective loans.
Plaintiffs called one witness, Winnes Wong, CPA. In calculating the prejudgment interest due on the amounts of the unpaid principal from the date of maturity of both loans (the measure of plaintiffs’ damages), Ms. Wong applied a prejudgment interest rate of 10 percent to both loans, even though the trial court had determined in the first phase that such prejudgment interest applied only to the 2009 loan.
Ms. Wong conceded that if no prejudgment interest was attributed to the unpaid principal on the 2008 loan (as was compelled by the court’s ruling in the first phase), there would be an overpayment by defendants of $84,914 on the two loans combined.
On such evidence, defendants orally moved for a directed verdict, based on plaintiffs’ failure to establish damages. The trial court construed defendant’s motion as a motion for judgment pursuant to Code of Civil Procedure section 631.8 and granted the motion.
The court issued its tentative decision, which became the final statement of decision, in which it found that plaintiffs had failed to establish damages.
Defendants filed a motion for attorney fees and costs as prevailing parties.
The court entered judgment pursuant to its statements of decisions under which plaintiffs took nothing by their operative complaint against defendants and defendants recovered from plaintiffs their costs of suit and attorney fees in amounts to be determined by the court.
Plaintiffs did not challenge the trial court’s ruling that the 16 percent interest rate on both loans was usurious and that each note was payable at maturity without the specified interest.
Further, they did not challenge the court’s ruling applying the 10 percent rate of prejudgment interest of Civil Code section 3289(b) to the 2009 loan.
However, as to the 2008 loan, they contended that they are entitled to prejudgment interest of 10 percent under article XV, section 1 of the California Constitution.
On loans not primarily for personal, family or household purposes, the California Constitution permits parties to contract for interest not to exceed the higher of 10 percent per annum or 5 percent over the amount charged by the Federal Reserve Bank of San Francisco on advances to member banks on the 25th day of the month before the loan. In the pertinent time periods here, the higher of these two rates was 10 percent.
Plaintiffs were entitled to prejudgment interest on the unpaid principal of the 2008 loan, but not at the rate of 10 percent to which the parties could have contracted under article XV, section 1, but rather at a rate of 7 percent (calculated from the date of maturity of the loan), which is the default prejudgment interest rate set by article XV, section 1 except as provided by statute.
Because the 16 percent interest rate on the 2008 and 2009 loans exceeded the constitutional maximum, the interest provisions were void and the notes were properly treated as if they called for no interest.
Despite the specified void interest rate established by the notes, plaintiffs were still entitled to prejudgment interest as provided by law on any unpaid principal at maturity.
Civil Code section 3289 provides rules for prejudgment interest rates applicable to breaches of contract. If the contract specifies a legal rate of interest, a court will apply that rate “after a breach [of contract] until the contract is superseded by a verdict or other new obligation.”
If a contract does not stipulate a legal rate of interest, a 10 percent per annum interest rate applies in the event of a breach.
However, “the term contract shall not include a note secured by a deed of trust on real property.”
In the present case, as the trial court correctly concluded, the 10 percent prejudgment interest rate of Civil Code section 3289(b) applied to the 2009 loan, which was not secured by a deed of trust, but not to the 2008 loan, which was.
But the inapplicability of Civil Code 3289(b) to the 2008 loan does not mean that plaintiffs were entitled to no prejudgment interest on any principal due at the date of maturity.
Besides permitting parties in certain situations to contract for a higher rate of interest, article XV, section 1 provides a default prejudgment interest rate of 7 percent per annum. It states in relevant part: “The rate of interest upon the loan or forbearance of any money, goods, or things in action, or on accounts after demand, shall be percent per annum but it shall be competent for the parties to any loan or forbearance of any money, goods or things in action to contract in writing for a [different] rate of interest” as specified.
The California Constitution provides for prejudgment interest at 7 percent per annum.
Thus, although no case (until now) has so held, as observed by a leading treatise, for a note secured by a deed of trust on real property, in the absence of a rate specified in the contract, the prejudgment rate will be seven percent.
Plaintiffs’ contention that the applicable interest rate is 10 percent per annum was without merit.
The constitutional provision merely allows parties to “contract in writing for a rate of interest” up to 10 percent.
Absent such a specified legal contract rate (and a promissory note with a void usurious rate is treated as having no rate specified), the default prejudgment interest rate remains at 7 percent, unless otherwise provided by statute.
The trial court erred in not applying prejudgment interest of 7 percent per annum to the 2008 loan, from the date of maturity to judgment.
LESSONS:
1. A lender should always require a promissory note that specifies a legal rate of interest.
2. If a contract stipulates a legal rate of interest, that rate is the applicable prejudgment rate under Civil Code § 3289(a).)
3. The California Constitution provides for prejudgment interest at 7 percent per annum.
4. For a note secured by a deed of trust on real property, in the absence of a rate specified in the contract, the prejudgment rate will be 7 percent per annum.
5. Always consider security in the form of a deed of trust for a promissory note, and the better security is a first deed of trust on real property that has sufficient value to allow recovery on the debt from a foreclosure sale.
6. The better practice is to specify an interest rate of no more than ten percent, unless the loan is "made or arranged" by a license real estate broker in which case the usuary laws do not apply, but that is a subject for another newsletter.