Private Lenders: what you need to know (Today)
By: Ella Zalkind of Beress & Zalkind PLLC
Engaging in private loans, also sometimes referred to as “hard money lending” is a high risk and high reward endeavor. However, due to various consumer oriented governmental protections in place, a lender needs to tread carefully and analyze the loan and its terms in addition to the documentation memorializing the loan very carefully. Private lenders must be mindful of various state and federal laws that our government has put into place to protect borrowers, even sophisticated borrowers. The consequence of a lender violating any of these laws is dire – namely that the loan in question will be deemed to be not legally owed — meaning that the borrower is off the hook. What makes this area even more tricky is that the laws differ in various states and are constantly changing and evolving. A smart lender needs to tread carefully and engage knowledgeable counsel before consummating any lending transaction.
First, many states have usury laws which effectively nullify loans and other lending transactions if the interest rate charged exceeds the state maximum allowed rate. This means that if a usury law is violated, a lender does not have a legal right to collect and the borrower is not obligated to pay, some or all of the principal and interest that may be due on a loan. The underlying public policy is to protect consumers from being victims of loans with excessive interest rates. A loan can be civilly usurious which means that a borrower can protest the loan with respect to the lender; or a loan can be criminally usurious which can expose a lender to criminal liability. In New York, this area of the law is governed by the General Obligations Law and the Banking Law for the civil rate limits and the New York Penal Law for the criminal limits.
The maximum rate depends on several factors such as the type of borrower and the amount of the loan. Loans made to individuals that do not exceed $250,000 are subject to a civil maximum annual interest of 16% and a criminal maximum annual interest of 25%. Loans that are made to individuals that are between $250,000 and $2.5 million have no maximum civil rate but are still subject to a maximum criminal rate of 25% annually. Loans made to corporations or limited liability companies that do not exceed $2.5 million are not subject to a maximum civil interest rate but are still subject to the 25% annual criminal interest rate. Loans that exceed $2.5 million are not subject to a maximum civil or criminal interest rate. It is worth noting that certain fees that may be charged to a borrower may be factored in to a calculation and determination of whether an interest was usurious. These fees can include points, origination charges and the like.
In addition, a lender needs to consider whether it requires to be licensed by the New York State Banking Department. New York Banking Law Section 340 requires that a lender who is in the business of making loans of $25,000 or less to “an individual for personal family, household, or investment purposes” and $50,000 or less for “business and commercials loans” where the interest or other charge exceeds the rate otherwise permitted, to obtain a license from the Banking Department. Thus, if a lender is not formally licensed by the Banking Department and makes a loan in violation of these limits, such loan will be deemed void and a lender would be unable to collect on this loan.
In addition to a loan being deemed void under applicable state law, lenders need to be mindful of federal laws. The Consumer Financial Protection Bureau (the Bureau) is an independent agency of the Federal Government that was created under the Consumer Financial Protection Act of 2010 (the CFPA). Specifically, the Bureau is charged with addressing violations of consumer financial laws including violations of the CFPA. Further, the Bureau has a broad sweep with authority to take action against institutions that engage in unfair, deceptive, or abusive acts or practices, or “that provide substantial assistance to other entities that do so.” This last category of institutions “that provide substantial assistance to other entities” could include marketing and technology companies that provides services to lenders. This broad legislation can be troubling for service providers to lenders and should not be taken lightly.
These are only a few of the concerns that issues that private lenders should be mindful of when embarking on a private lending transaction. Of course the lender needs to consider the business aspect of a transaction and conduct proper due diligence to ensure that the loan to value ratio work; that there is sufficient security to back up the loan in case of a default (i.e. a property in the case of a loan secured by real estate, also known as a mortgage); if the borrower is an entity, to ensure that financially solid guarantors are on the hook, and so forth. The documentation underlying the loan needs to accurately reflect the terms of the transaction such as the stated interest rate, the maturity date, the guarantors, the security, etc. In the case of a loan backed by security, depending on the type of security interest granted, certain additional steps are required such as recording of a mortgage and/or lien (a UCC filing) on the relevant property or assets.
In summary, it is critical to note that in this current economic and financial environment, the breath of laws and regulations at both the state and federal level is ever changing and always evolving. It behooves a smart lender to engage knowledgeable counsel as early in the transaction process as possible.