A Practitioner’s Guide to Understanding Interest

April 12th, 2017

While prohibited in some religious traditions,1 interest is one of the most pervasive concepts in the American economy. Seemingly simple on its surface, it presents a bewildering amount of complexity as soon as one digs into its legal implications. Real Estate practitioners must know the rules of interest when negotiating a mortgage or charging rent to knowing the full monetary stakes of litigation.

When Interest Attaches

In New York litigation, there are three periods to consider regarding interest: the claim until verdict or decision, from then until judgment, and from judgment to payoff. CPLR 5004 dictates that all three time periods shall qualify for 9 percent simple annual interest unless the parties contract2 some other rate below usury.3 CPLR 5003 allows interest on any money obligation reduced to judgment, including judgments on claims that do not carry interest prior to judgment.4 Equitable claims can also garner interest, in the court’s discretion.5 28 USCA. §1961 does the same thing for federal claims. Such section sets interest at “a rate equal to the weekly average one-year constant maturity Treasury yield, as published by the Board of Governors of the Federal Reserve System, for the calendar week preceding the date of the judgment.” In federal litigation, the New York interest rate governs pre-judgment and the federal rate post-judgment, both “unless the parties in clear, unambiguous and unequivocal language, stipulate otherwise.”6

 

Computing Simple Interest

CPLR 5001 defines the date which interest is computed as “the earliest ascertainable date the cause of action existed. In cases where damages incurred at various time interest is computed upon each item from the date it was incurred or upon all of the damages from a single reasonable intermediate date.” In cases where there are damages that accrued at different times, such as torts, interest can be computed separately on each segment measured from its own moment of accrual. In selecting the intermediate date, courts have considerable latitude, but if all the amounts at the various dates are roughly equal in amount, courts frequently choose a date that is simply half way between the first and last date the liabilities accrued.

For foreclosure actions “in an action on a promissory note, CPLR 5001 permits a creditor to recover prejudgment interest from the date on which each payment of principal or interest became due under the terms of the note until the date which liability is established…. [However, i]f a promissory note does not contain an interest provision but is payable on demand, then interest accrues from the date of the demand, at the statutory rate for judgment.”7

 

Problems Calculating Interest

Band Realty v. N. Brewster8 holds “interest on the whole amount of principal agreed to be paid at maturity not exceeding the legal rate, may be taken in advance.”

Spodek v. Park Property Development9 had a note calling for monthly payments, each requiring a separate calculation of interest running from each defendant individually. Defendants’ defaults went beyond the six-year statute of limitations. The court allowed the defaults within the six years to be entitled to a CPLR 5001 interest calculation, holding it simple interest. Totaling the sum separately calculated amounts for judgment was not found compounding of interest, but just addition.

 

Higher Interest By Contract

Parties can validly contract for interest above the statutory rate, but below the usury rate.10 “It is well settled that when a contract provides for interest to be paid at a specified rate until the principal is paid, the contract rate of interest, rather than the legal rate set forth in CPLR 5004, governs until payment of the principal or until the contract is merged in a judgment.”11 “Where there is a clear, unambiguous, and unequivocal expression to pay an interest rate higher than the statutory interest rate until the judgment is satisfied, the contractual interest rate is the proper rate to be applied.”12

 

Usury Statutes

New York has three usury statutes: General Obligations Law (GOL) §5–501[2], Banking Law §§14–a [1] & 108 and Penal Law §190.40. The GOL and Banking Law sets the maximum interest rate at 16 percent. The Penal Law establishes a rate of 25 percent as a felony. In all cases, the rate is the effective annual rate.

Courts construe GOL §5–501[2]’s “interest on the loan or forbearance” literally. It only affects loaned money and not merely owed money like rent. Protection Industries v. Kaskel13 specified that a late fee is not a forbearance and in F. K. Gailey v. Wahl,14 the court wrote:

We reject defendant’s contention that the late fee of 2 percent charged by plaintiff was usurious. The late fee was not a loan or forbearance of money and thus the usury statute does not apply.

While privately imposed interest penalties meant to be so punitive as to discourage any possibility of lateness are unacceptable, usury does not apply to municipal impositions on citizens. In Waterbury v. City of Oswego,15 the court held:

We also reject plaintiff’s contention that the late fee is usurious under General Obligations Law §5–501(2). The late fee is a penalty for failure to pay a water bill when due. It is designed to insure the prompt payment of water bills and is clearly not a loan or forbearance of money. Where there is no loan, there can be no usury.

Seidel v. 18 East 17th Street Owners16 held, “If the transaction is not a loan, there can be no usury, however unconscionable the contract may be.”

However, pursuant to GOL 5–501(6)(a), where the loan or forbearance amounts to $250,000 or more, there is no limitation below criminal usury on the amount of interest one may charge.17

 

Usury Analysis Applied

In spite of the principal that “usury” is inapplicable for anything but a loan, usury analysis still voids a contract where the penalties for late payment are too severe. Courts look at flat late fees and recompute them as interest percentages and then invoke the usury statutes. Sandra’s Jewel Box v. 401 Hotel,18 stated:

Moreover, the late charge provision of the lease, which awarded a 365 percent per annum penalty, should not be enforced. The charge, while not technically interest, is unreasonable and confiscatory in nature and therefore unenforceable when examined in the light of the public policy expressed in Penal Law §190.40, which makes an interest charge of more than 25 percent per annum a criminal offense.

Clean Air Options v. Humanscale,19 held “The late fee, which according to the parties’ calculations results in an annual interest rate of 78 percent, is ‘unreasonable and confiscatory in nature.’”20

“A corporation may not interpose a defense of civil usury… An individual guarantor of a corporate obligation is also precluded from asserting such a defense… However, where a corporate form is used to conceal a usurious loan made for personal, not corporate purposes, the defense of usury may be interposed… Further, the prohibition against asserting such a defense does not apply to a defense of criminal usury where interest in excess of 25 percent per annum is knowingly charged.”21

Under 12 U.S.C. § 1735f-7a(a)(1), federal law preempts State usury laws for first mortgages on real property made after March 31, 1980 for federally related mortgage loans.22Wolfert v. Transamerica Home First,23 found New York usury laws preempted under this statute.

 

Estoppel

Seidel,supra, instructed on two variants of the theory of estoppel in pais. The first is when the supposed victim of usury executes an estoppel certificate. The certificate serves to prevent a later contest by the certificate’s signor on the basis of usury. The second is where the supposed victim of the usury is the one who engineered the usurious arrangement, provided there is an intimate relationship between the usurer and the usuree so that the usuree tricked usurer into the usury. Pemper v. Reifer,24 held:

The fact that the borrower sets the rate of interest does not relieve the lender from a defense of usury.…In this regard, a borrower, who, because of a fiduciary or other like relationship of trust with the lender, is under a duty to speak and who fails to disclose the illegality of the rate of interest he proposes, is estopped from asserting the defense of usury where the lender rightfully relies upon the borrower in making the loan.

Thus, this latter form of estoppel in pais is limited to relationships where the nature of the relationship is such that at least one of the parties has a background with the other giving rise to a heightened sense of trust, rather than arms’ length.

 

Compound Interest

Spodek v. Park Prop.25 explains, “Compound interest is commonly defined as ‘interest on interest’ or interest that is ‘paid on both the principal and the previously accumulated interest.’ This contrasts with simple interest, which is ‘paid on the principal only and not on accumulated interest.’”

For example, consider a $100 January first debt at 2 percent/month. Assuming the debt remains unpaid, at simple interest, the accumulated interest is 12 x 2 percent or 24 percent for a payoff of $124.00.

Now, let us use compound interest at 2 percent interest per month. At the end of January, the debt has grown to $102 ($100 + 2 percent of $100). At the end of February, $104.04 ($102 + 2 percent of $102), then March, $106.12 ($104.04 + 2 percent of $104.04). Continuing this pattern through the year, the accumulated debt at the end of December is $126.82. The accumulated interest is $26.82 nearly two points above criminal usury.

With certain exceptions, such as usury, GOL 5-527 permits compound interest. The law assumes simple interest unless the parties contract otherwise. “[M]ere silent acquiescence in [an] account stated [does] not constitute an express promise to pay compound interest.”26

Technically, the explanation of compound interest above given was for “periodic compound interest” where the compounding takes place at the end of some fixed period like once a month, but it could be any fixed period such as weekly, biweekly, or annually. The only limitation is the usury laws that look to how the interest adds up for a one-year period, regardless of how it is achieved. Non-periodic compound interest occurs with certain landmark events that take accumulated interest and effectively adds it to the principal of the debt before establishing that principal plus interest as the new principal to which to apply fresh interest. Thus, where a contract called for interest, it normally is charged until the judgment and is then fixed at that amount, to which the statutory post-judgment interest is now imposed, effectively “compounding” the interest by the event of the entry of judgment.27

While normal judicial awards against a governmental body are, like those against private citizens, simple interest, eminent domain presents a special case. Since the courts are seeking to have the private party put in economically the same situation the private party would have been in but for the taking, 520 East 81st Street Associates v. State of New York,28 awards the takings plaintiff compound interest until the entry of judgment, but simple interest thereafter.

Late Fees and Interest

“Late fees” and “interest” are apparently different. But, when basing the fixed fee on lateness of a fixed payment, dividing the former by the latter yields a percentage.

However, a “transaction must be considered in its totality and judged by its real character, rather than by the name, color, or form which the parties have seen fit to give it.”29 In denying summary judgment on a promissory note, Lugli v. Johnston30 held:

Specifically, the defendant raised triable issues of fact with his contention that the annualized rate of the subject loan was at least 30 percent, in light of the combined annualized rates for interest and the loan origination fee, and that the loan’s interest rate was, thus, in excess of the amount allowed by General Obligations Law §5–501(1) and Banking Law §14–a(1). In determining whether a transaction is usurious, the law looks not to its form, but its substance, or real character.

Conclusion

While on its surface, the concept of “interest” appears to be a simple matter of calculating a percentage of what someone owes, the legal development of interest in New York law shows far greater complexity beneath the surface and far greater importance in understanding the amount of money that can be charged and collected.

ENDNOTES:

*The authors would like to thank Hofstra Law student and Adam Leitman Bailey Spring extern and 2017 summer associate, Carly Clinton, for her research and assistance with the preparation of this article.

  1. As to Judaism, interest is forbidden at Deuteronomy 23:19. Some Christians interpret a similar rule based on Matthew 5:42 combined with the provision from Deuteronomy and other similar provisions. Islam has similar prohibitions in the Quran at 3:130. However, all of these religious provisions have interpreters who say that only usury is prohibited.
  2. Lisa Stifler, “Debt in the Courts: The Scourge of Abusive Debt Collection Litigation and Possible Policy Solutions,” 11 Harv. L. & Pol’y Rev. 91, 112 (2017).
  3. IRB-Brazil Resseguros v. Inepar Investments , 83 AD3d 573 (2011).
  4. CPLR 5001.
  5. Id.
  6. FCS Advisors v. Fair Fin. , 605 F.3d 144 (2d Cir. 2010).
  7. Gliklad v. Cherney , 132 AD3d 601 (1st Dept. 2015).
  8. 37 NY2d 460 (1975).
  9. 96 NY2d 577 (2001).
  10. Astoria Fed. Sav. & Loan v. Rambalakos , 49 AD2d 715 (1975).
  11. Citibank v. Liebowitz , 110 AD2d 615 (1985).
  12. Retirement Accounts v. Pacst Realty , 49 AD3d 846 (2d Dept. 2008).
  13. 262 AD2d 61 (1st Dept. 1999).
  14. 262 AD2d 985 (4th Dept. 1999).
  15. 251 AD2d 1060 (4th Dept. 1998).
  16. 79 NY2d 735 [1992].
  17. Bristol Inv. Fund v. Carnegie Int’l. , 310 F. Supp. 2d 556 (SDNY 2003).
  18. 273 AD2d 1 [1st Dept. 2000].
  19. 142 AD3d 923 (1st Dept. 2016).
  20. See also, Hankin v. Armstrong , 113 Misc2d 24 (AppT 9 & 10 1981).
  21. Tower Funding v. David Berry Realty , 302 AD2d 513 (2003).
  22. 12 U.S.C. 1735f–5(b).
  23. 439 F.3d 165 (2d Cir. 2006).
  24. 264 AD2d 625 [1999].
  25. Spodek v. Park Prop. Dev. , 96 NY2d 577 (2001).
  26. R.F. Schiffmann v. Baker & Daniels, No. 3072, 2017 WL 535875 (NY App. Div. Feb. 10, 2017).
  27. Spodek, supra.
  28. 19 AD3d 24 (2005).
  29. Feinberg v. Old Vestal Rd. Assocs ., 157 AD2d 1002 (3d Dept. 1990).
  30. 78 AD3d 1133 (2d Dept. 2010).

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