Understanding Usury: Is It an Investment, or Is It a Loan?

Imagine making a loan to a business for its use as start-up capital. Loan documents are drafted, and to secure payment, you retain an option to purchase equity in the company. If the company doesn’t pay on time, you may have the option to take control of the company. The interest rate on the money lent is above market rate, but it doesn’t rise to the level of loan sharking. Savvy investors and lenders should carefully consider how Florida law views an equity share and interest on a loan to ensure the transaction does not violate the usury laws, rendering your loan illegal or void. An agreement in the form of an investment for a return of “profit”, may be deemed “interest”, if the substance of the agreement is truly a loan.

What is a usurious loan?

A usurious transaction has four elements: (1) existence of a loan express or implied; (2) an understanding between the parties that money lent shall be returned; (3) that for such a loan a greater rate of interest than is allowed by law shall be paid or agreed to be paid; and (4) lender’s corrupt intent to take more than the legal rate for use of money loaned. Dixon v. Sharp, 276 So. 2d 817, 819 (Fla. 1973). The penalties for making a usurious loan can have harsh consequences, rendering the interest, and even the entire loan, invalid and illegal. 

Penalties for civil usury include forfeiture of double the interest that the lender actually charged and collected.  See Fla. Stat. § 687.04.  In the context of criminal usury, the civil remedy is forfeiture of the right to collect the debt.  See Fla. Stat. § 687.071(1).

Usury is largely a matter of intent, which is determined by whether there was a purpose in mind to obtain more than legal interest. W. B. Dunn Co., Inc. v. Mercantile Credit Corp., 275 So. 2d 311, 314 (Fla. 1st DCA 1973). Florida law has determined that business owners are free to buy and sell their property, including promissory notes and other instruments, at a price agreed upon, and when the bona fides of the parties is established, the percentage of profit has no relation to usury. Indian Lake Estates, Inc. v. Special Investments, Inc., 154 So. 2d 883, 889 (Fla. 2d DCA 1963). All of the negotiations, circumstances and conduct of the parties surrounding and connected with their contracts may be material in determining whether the form thereof covered an intent to violate the usury law, and the burden of establishing evasion must be met by evidence clearly showing the intent. Id.

Calculating the effective interest rate for purposes of usury

The Florida Supreme Court announced the rule for calculating usurious interest in St. Petersburg Bank & Trust Co. v. Hamm, as provided in the following manner: (i) the spreading of any such [loan charge] for the purpose of computing the rate of interest shall be calculated by first computing the advance or forbearance as a percentage of the total stated amount of the loan…; (ii) this percentage rate shall then be divided by the number of years, and fractions thereof, of the loan according to its stated maturity date, without regard to early maturity in the event of default…; (iii) and the resulting annual percentage rate shall then be added to the stated annual percentage rate of interest to produce the effective rate of interest…. St. Petersburg Bank & Trust Co. v. Hamm, 414 So.2d 1071, 1073 (Fla.1982).

If repayment is “speculative” or “contingent”, the return on investment is not considered interest for purposes of usury

The laws against usury strike a balance between the risk of investment (and the risk of loss), which could reward risky investments handsomely—as opposed to the mere cost of borrowing money, which is guaranteed repayment on a loan. For example, people should be free to make speculative investments and see returns in excess of 25%, which are contingent on the success of the business venture. However, it is the non-speculative guarantee of a return that is considered interest for purposes of usury.

Accordingly, the law provides express exceptions for interests in speculative profits. Section 687.03(4), Florida Statutes provides “If… a line of credit… exceeds $500,000, then, for the purposes of this chapter, interest on that…line of credit…shall not include the value of property charged, reserved, or taken as an advance or forbearance, the value of which substantially depends on the success of the venture in which are used the proceeds of that … line of credit… Stock options and interests in profits, receipts, or residual values are examples of the type of property the value of which would be excluded from calculation of interest under the preceding sentence.”

Florida courts interpreting Fla. Stat. 687.03(4) have found a profit participation provision is expressly authorized by Florida usury statutes as not constituting additional interest, because payment depends upon a contingency and success of the underlying venture. Bailey v. Harrington, 462 So. 2d 861, 862 (Fla. 3d DCA 1985); Valliappan v. Cruz, 917 So. 2d 257, 260 (Fla. 4th DCA 2005); Saralegui v. Sacher, Zelman, Van Sant Paul, Beily, Hartman & Waldman, P.A., 19 So. 3d 1048, 1051 (Fla. 3d DCA 2009).

In Bailey, the borrower included a profit participating provision that entitled it to a share of 43% of the profits. 462 So. 2d at 861. The Third DCA held that the profit participating provision could not constitute additional interest because if the development was not profitable, then the lender would not collect any money.

In Oregrund Ltd. Partnership v. Sheive, 873 So. 2d 451 (Fla. 5th DCA), the court considered a case where a developer borrowed $600,000 for a business venture, but the lender received a 50% interest in a separate 8.4-acre tract that the developer wanted to later develop. The developer retained the option to buy-back the full interest in the 8.4 acre-tract. The terms of the Option were that if the developer exercised its right to repurchase the tract in the first year following the sale of the business venture for which it received the loan, the repurchase price was $1.2 million, if it exercised its right to repurchase in the second year, the price was $1.8 million. The tract was valued in excess of $5 million, and the maximum mortgage loan against the tract at the time of the development loan was $1.8 million. The appellate court determined that for $600,000, the lender received a one-half interest in the tract which carried with it a non-speculative value of over $2.5 million. Therefore, despite the fact that the loan was in excess of $500,000, the equity interest included in the loan was not exempt from the usury interest calculation because it was not speculative.

In other words, Florida courts exclude profit participation provisions from usury calculation. However, when determining if a profit share provision is disguised as a loan, it is the substance of a transaction, rather than its form, that must be scrutinized in ascertaining whether a transaction, not appearing in the form of a loan, is in fact a usurious loan.  For a transaction to be labeled usurious there must be a loan, either expressly or impliedly created, an understanding that the money is to be repaid at a rate greater than allowed by law, and a corrupt intent on the part of the lender to extract more than the legal rate of interest. Florida Trading & Inv. Co., Inc. v. River Const. Services, Inc., 537 So. 2d 600, 602–03 (Fla. 2d DCA 1988).

Conclusion

Business investors and their legal counsel should understand the nuances between a true investment with the speculative risk of a return, and how such transactions can be deemed a loan for purposes of usury.  Failure to do so can come with extreme consequences under the laws against usury.