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Hybrid debt/equity transactions: do they intersect with the usury laws?

One of your regular clients, Carey Capital, asks you to spend a few minutes to look over the terms of a deal in which he plans to make a small investment. You review his handwritten notes. The material terms are straightforward and seem innocuous: "Mr. Capital agrees to lend Sally Sweat $25,000 to fund the start up of an Internet business.... Ms. Sweat agrees to repay the loan at a 10 percent interest rate.... Mr. Capital will keep the partnership books, assist in the office, and provide Ms. Sweat with business advice.. Ms. Sweat will run the day-to-day operations.... Mr. Capital is entitled to 10 percent of the partnership's profits." The agreement is unremarkable, a small loan rolled into a partnership agreement. Your biggest concern is whether Ms. Sweat or the Internet company has any assets that can stand as security for the loan. Hopefully, you do not overlook the usury laws when advising Mr. Capital.

Overview of Usury Law

Usury has ancient roots. (1) The Old Testament commands that "[t]hou shall not lend upon usury to thy brother" (2) or "take usurious interest from him." (3) Early Judeo-Christian communities regarded the practice of charging interest an immoral sin. (4) Aside from prohibiting usury in particular religious traditions, usury was condemned by the Roman Republic in 340 B.C. when anti-usury laws were enacted. (5) As the Florida Supreme Court long ago explained, "[t]he very purpose of statutes prohibiting usury is to bind the power of creditors over necessitous debtors and prevent them from extorting harsh and undue terms in the making of loans." (6)

Florida's usury laws, set forth in F.S. Ch. 687, prescribe a maximum rate of interest of 18 percent on loans of less than $500,000. (7) On loans that exceed $500,000, the maximum legal rate of interest is 25 percent. (8) Significantly, it is a criminal offense--misdemeanor or felony--to provide loans which have effective interest rates of 25 percent or more, but less than 45 percent. (9) Interest rates that exceed 45 percent are punishable as a third degree felony. (10)

The consequences of a usurious loan are severe. First, the loan may become unenforceable in whole or in part. If a loan is deemed usurious, the lender forfeits all interest charged. (11) With respect to loans deemed to be criminally usurious, in addition to forfeiting the interest, the entire debt becomes unenforceable. (12) Second, with respect to loans deemed usurious or criminally usurious, the lender may be liable to the borrower for damages in the amount double the amount of interest taken. (13) Third, with respect to any usurious loan, the lender may be liable for the borrower's attorneys' fees. (14)

In determining whether a loan is usurious, the court considers the substance of the transaction, rather than its form. (15) In its examination of the transaction, the court will deem certain lender charges as interest. (16) When the interest rate and lender charges are considered in tandem, and the latter is deemed interest, the charge must be valued as of the date received and spread over the term of the loan, advance of money, or line of credit. (17) Accordingly, when the court construes the lender charges and the stated interest rate on the loan together, the effective interest rate is often excessive and violates Florida's anti-usury statutes. Despite the confusion over lender charges, the usury statutes fail to exhaustively enumerate what charges should be deemed interest and in what circumstances. Without guidance from the legislature, it is difficult for investors and lenders to anticipate the potential consequences of their agreements. (18)

Attorneys must be aware of the anti-usury statutes and the judicial construction when advising clients. Although the statutes do not enumerate the lender charges that are considered interest, it is significant that the courts, in certain circumstances, have recharacterized equity interest in a partnership as interest. As such, attorneys must be careful not to violate the usury laws when drafting loan and partnership agreements.


Recharacterization of Equity Share as Interest

Turning to the hypothetical scenario set forth in the introduction, there is very little Florida case law as to whether a lender's equity share should be deemed interest in a hybrid debt/equity investment. (19) In Jersey Palm-Gross, Inc. v. Paper, 658 So. 2d 531 (Fla. 1995), a real estate partnership sought to develop its property located in West Palm Beach to construct a multi-tenant office building. (20) The lots were valued at $1.7 million, but were encumbered by a $1.1 million purchase money mortgage that was nearly due. (21) The partnership secured a loan from a bank to satisfy the purchase money mortgage, and the remaining funds were to be applied to the construction project. (22) Despite the bank loan, the partnership was $200,000 short. (23) In seeking to bridge the gap, the partnership approached Walter Gross, a real estate developer, and suggested that he become an equity partner in the partnership for $200,000. (24) Gross agreed to lend the $200,000, but initially refused the partnership offer. (25) When the loan documents were presented to the borrowers, however, Gross had included a demand for 15 percent ownership interest in the partnership. (26) With closing imminent and no alternative financial source, the borrowers executed the agreement. (27) When the borrowers defaulted on the loan, Gross brought suit. The borrowers' defense was that the loan was usurious because the interest rate, which included the 15 percent equity interest in the partnership, totaled 45 percent per annum, in violation of Florida's anti-usury statutes. (28) In holding that the loan was usurious, the court scrutinized the loan and equity share together. (29) Ultimately, the Florida Supreme Court recharacterized the ownership share as interest because the lender had the intent to extract an excessive interest rate. (30)

Although the Florida Supreme Court in Jersey Palm-Gross scrutinized the loan and equity agreement together, the case should not be construed to mean that any time a lender takes an equity share contemporaneously with a loan that the equity share is deemed interest. In the hypothetical presented at the beginning of this article, the lender earns his compensation (equity share) because he contributes services to the partnership. An investor who also contributes services to the business in which he or she invests is not simply a lender--he or she should be rewarded for his or her efforts. By Mr. Capital keeping the partnership books, assisting in the office, and providing Ms. Sweat with business advice, he contributes services to the partnership that entitles him to compensation. This compensation is in the form of an equity interest in the partnership. As such, a court that construes the equity share and interest on the loan together and finds the agreement between Mr. Capital and Ms. Sweat unenforceable for violating anti-usury laws has overlooked the time and services that Mr. Capital contributed. In Jersey Palm-Gross, the lender apparently did not contribute services to the partnership that would entitle him to compensation. The legislature should amend F.S. Ch. 687 to clarify this point.

Drafting Hybrid Debt/Equity Agreements

Attorneys should be aware that Florida courts have construed equity share in a partnership and interest on a loan together in determining if a loan is usurious. (31) As a result, attorneys must advise their clients of the unintended consequences of taking an equity share in connection with a loan agreement. Attorneys should carefully draft partnership and loan agreements to avoid a future lawsuit.

Attorneys drafting partnership and loan agreements must select and define the terms carefully to avoid the perception of concealing usury. In Pinchuck v. Canzoneri, 920 So. 2d 713 (Fla. 4th DCA 2006), the borrower and lender entered into an agreement in which the borrower would repay the amount borrowed plus an "investment profit." The effective interest rate amounted to 144 percent of return on principal. (32) The court found that the term "investment profit," which was used to describe the amount to be paid above the principal, could not be used to conceal usury. (33) As such, couching an agreement in investment terms will not necessarily insulate the agreement from being usurious. Specifically, an agreement in the form of an investment in which the return is labeled "profit," as opposed to "interest," will be deemed a loan if the substance of the transaction is a loan. (34)

Attorneys drafting joint loan and partnership agreements should explicitly recite what the capital partner is contributing to the partnership in addition to the capital. These services may include, among other things, the following: business advice, accounting/bookkeeping services, legal services, management services, computer/technology support services, and marketing. Any contribution that the investing partner expects to make to the partnership, no matter how insignificant, should be specifically delineated in the partnership agreement. The purpose of outlining the obligations is to protect the investor's equity share in the partnership. Drafting the agreement in such a way will provide evidence of the parties' intent that the investor's equity share in the partnership is in consideration for the time and services that the investor provides to the partnership. Stated differently, the recitals will evidence the parties' intent that the investor's equity share is not in consideration for the loan. The partnership agreement should reflect this notion. A partnership agreement that specifically sets forth the investing partner's contributions will serve useful during discovery.

Another issue attorneys should consider in drafting is the mechanics of how the investing partner will be paid. In an effort to have a court construe the equity share and the interest on the loan separately, the lender can demand separate payments of loan repayment and equity distributions. (35) Similarly, it is advantageous for the loan agreement to be set forth in a separate instrument (as opposed to in the partnership agreement). Courts are supposed to look at the substance of a transaction, rather than its form; nevertheless, taking these steps can help avoid judicial confusion over the substance of the transaction.

An additional consideration in regard to payment is that a payment obligation that is speculative will not be deemed interest for purposes of determining if a loan is usurious. (36) For instance, revenues to be derived from an equity share may be speculative if there is no assurance that a business will generate any revenue (e.g., a start-up business). In other words, a payment dependent on a contingency cannot make a loan usurious at the outset because it is unknown whether the lender will collect anything. However, attorneys should include a usury savings provision in the agreement to protect the investor/lender when the business is more established and the borrower can argue that the share of profits is less speculative. (37) The clause will serve as evidence to rebut an allegation of usurious intent. (38)

Attorneys should be aware that the inclusion of a usury savings clause in a partnership/loan agreement, by itself, will not preclude a finding of usury. Jersey Palm-Gross suggests that a capital partner might include a usury savings clause in a loan agreement to create an opportunity to later claim a lack of corrupt intent. (39) However, a contractual disclaimer, such as a usury savings clause, is not a "silver bullet." In Jersey Palm-Gross, the inclusion of a usury savings clause did not warrant an automatic dismissal of a usury cause of action. (40) The presence of a usury savings clause is only one factor in determining whether the lender possessed intent to exact a usurious rate of interest. (41)

A well-drafted partnership agreement should include a prevailing party's attorneys' fees provision. The statute provides that borrowers may recover their attorneys' fees in connection with a usury claim. (42) Unfortunately, the statute does not expressly state that lenders may recover their attorneys' fees in successfully defending a usury claim. Consequently, the legislature should amend Ch. 687 to make it clear that a lender prevailing on a usury claim may recover his or her attorneys' fees. Without legislative action to amend the statute, it is crucial for the attorney drafting the hybrid loan/equity agreement to include a prevailing party's attorneys' fees provision to protect the lender in case he or she is hailed into court to litigate a usury claim, counterclaim, or defense.

Litigating a Usury Claim

Notwithstanding a well-drafted partnership agreement, a borrower may seek to interpose usury as a defense or an affirmative claim in a lawsuit. In litigating a usury issue, the attorney representing the investing partner should exhaustively explore the services the capital partner provided to the partnership. In that vein, the recitals contained in the partnership agreement may serve as a good "road map" for various discovery efforts.

Aside from exploring the services the capital partner provided to the partnership, in defending a usury action, a critical issue is the lender's intent. A lender must possess (at the inception of the agreement) a corrupt intent to take more than the legal rate of interest. (43) In a usury action, establishing a corrupt intent requires examining the lender's subjective state of mind. (44) A corrupt intent is not determined by the fact that the lender receives more than the law permits; rather, it is determined by the existence of a corrupt purpose in the lender's mind to receive more than the legal rate of interest. (45)

The plain language of F.S. [section] 687.03 indicates that it constitutes usury for any person to willfully "reserve, charge, or take" a sum of money equivalent to a rate of interest greater than 18 percent. (46) Skillful attorneys will litigate over what is meant by "willful" in this context.

Older cases suggest that merely receiving interest in excess of the legal rate satisfies the intent requirement. (47) By focusing on the "reserving, charging, or taking" statutory language, the borrower will neglect to meet his or her burden of proving that the lender had (at the inception of the agreement) a corrupt intent to charge an unlawful rate of interest. (48) Yet, F.S. [section] 687.04 imposes penalties on a lender who willfully violates [section] 687.03. It is a basic principle of statutory construction that all provisions of a statute should be given effect. (49) The "willful" requirement would have no effect if a borrower only needed to establish that the lender charged or received interest in excess of the legal rate. Therefore, courts should not relieve borrowers of the obligation to prove the lender's corrupt intent to violate the law.

Summary Judgment: A High Hurdle for Innocent Lenders

When the borrower seeks to recharacterize an equity share or other fee as usurious interest, the lender's simplest defense may be that he or she lacks corrupt intent. Corrupt intent is generally a question of fact, as opposed to a question of law. (50) Case law supports examining all circumstances surrounding a transaction to determine if it is usurious. (51) Therefore, it is challenging for a lender or capital partner to obtain summary judgment. Even with a very weak usury claim, a borrower may extract a significant settlement or concession from a lender or capital partner who faces the prospect of incurring attorneys' fees through trial.

Nevertheless, at least two reported Florida cases have granted lenders summary judgment when the borrower offered no proof of corrupt intent. (52) Courts should not allow meritless usury actions to proceed to a jury, especially in the usury context. It has been held that a mistrial was proper when the court allowed the jury to decide a meritless usury defense because of the powerful effect of the term "usury" on the listener. (53)


In the hypothetical situation above, the stated interest rate is well under the legal limit. However, if the capital partner's minority profit share (which could be very lucrative if the business is successful) or ownership share are recharacterized by a court as interest, the effective interest rate may render a transaction usurious. A shrewd plaintiffs' lawyer may advise Ms. Sweat that she can stop sharing profits with her partner and file a lawsuit against the capital partner, with the end game of a "walk-away" settlement or even a recovery for the borrower/service partner. As a practical matter, many capital partners will make a business decision to pay a settlement amount to their partners (who breached the partnership agreement) or will decide it is not economical to collect full payment from his or her partner in light of the substantial attorneys' fees involved with litigating the usury claim and/or defense. Finally, the innocent lender or capital partner who ultimately prevails may end up bearing his or her own attorneys' fees from the borrower unless the relevant contract contains an attorneys' fees provision.

(1) Susan Lorde Martin, Financing Litigation On-Line: Usury & Other Obstacles, 1 DePaul Bus. & Com. L. J. 85, 89 (2002).

(2) The Bible, Deuteronomy 23:19.

(3) Id. at Leviticus 25:35.

(4) James M. Ackerman, Interest Rates and the Law: A History of Usury, 27 Ariz. St. L. J. 61, 72-73 (1981).

(5) John D. Skees, Comment, The Resurrection of Historic Usury Principles for Consumption Loans in a Federal Banking System, 55 Cath. U. L. Rev. 1131, 1140-41 n.57 (2006) (citing Wayne A.M. Visser & Alastair McIntosh, A Short Review of the Historical Critique of Usury, reprinted in History of Usury Prohibition (1998)), available at

(6) Chandler v. Kendrick, 146 So. 551, 552 (Fla. 1933).

(7) Fla. Stat. [section] 687.03 (2009).

(8) Fla. Stat. [subsection] 687.03, 687.071 (2009).

(9) Fla. Stat. [subsection] 687.071(2), (3) (2009).

(10) Fla. Stat. [section] 687.071(3) (2009).

(11) Fla. Stat. [section] 687.04 (2009).

(12) Fla. Stat. [section] 687.071(7) (2009).

(13) Fla. Stat. [subsection] 687.147, 687.04 (2009).

(14) Id.

(15) Pinchuck v. Canzoneri, 920 So. 2d 713, 715 (Fla. 4th D.C.A. 2006); Fla. Trading & Inv. Co., Inc. v. River Constr. Servs., Inc., 537 So. 2d 600, 602-03 (Fla. 2d D.C.A. 1988); Am. Acceptance Corp. v. Shoenthaler, 391 F.2d 64, 69 (Former 5th Cir. 1968).

(16) In re Boiling, 2008 WL 5100204 *7 (M.D. Florida 2008); see, e.g., Jersey Palm-Gross, Inc. v. Paper, 658 So. 2d 531 (Fla. 1995).

(17) Fla. Stat. [section] 687.03(3) (2009).

(18) In re Boiling, 2008 WL 5100204 *7 (M.D. Florida 2008) (stating that "[i]n contemplating whether a transaction is usurious, courts can consider whether other amounts charged by a lender in connection with financing may be regarded as interest") (emphasis added).

(19) This article will often refer to this type of arrangement by the generic term "partnership." It is the authors' intent that "partnership" in this context refers to partnerships, joint ventures, and similar arrangements.

(20) Jersey Palm-Gross, 658 So. 2d at 532.

(21) Id.

(22) Id. at 532-33.

(23) Id.

(24) Id. at 533.

(25) Id.

(26) Id.

(27) Id.

(28) Id.

(29) Id. at 535-36.

(30) Id.

(31) See id.

(32) Pinchuck v. Canzoneri, 920 So. 2d 713, 714 (Fla. 4th D.C.A. 2006).

(33) Id. at 715.

(34) Id.

(35) Separating these payments may also I serve to clarify an investor's tax liability.

(36) Oregrund Ltd. P'ship v. Sheive, 873 So. 2d 451, 456 (Fla. 5th D.C.A. 2004) (citing Hurley v. Slingerland, 461 So. 2d 282, 283 (Fla. 4th D.C.A. 1985); Kraft v. Mason, 668 So. 2d 679 (Fla. 4th D.C.A. 1996); Diversified Enter., Inc. v. West, 141 So. 2d 27 (Fla. 2d D.C.A. 1962)).

(37) In Jersey Palm-Gross, 658 So. 2d 531, 535 (Fla. 1995), the court states that a usury savings clause is proper "[w]here the transaction is not clearly usurious at the outset but only becomes usurious upon the happening of a future contingency, [because] the clause may be determinative on the issue of intent."

(38) See Harvey v. Lake Buena Vista Resort, LLC, 568 F. Supp. 2d 1354, 1365 (M.D. Florida 2008) ("A savings clause in general is designed to protect the parties to a contract from changes in the law or the parties' circumstances that occur after the contract has been entered into.").

(39) See, e.g., Harvey, 568 F. Supp. 2d at 1365 (M.D. Florida 2008); Jersey Palm-Gross, 658 So. 2d 531, 535 (Fla. 1995).

(40) Levine v. United Co. Life Ins. Co., 659 So. 2d 265, 267 (Fla. 1995) (citing Jersey Palm-Gross, Inc. v. Paper, 658 So. 2d 531 (Fla. 1995)).

(41) Id.

(42) Fla. Stat. [section] 687.147 (2009).

(43) Rebman v. Flagship First Natl Bank of Highlands County, 472 So. 2d 1360 (Fla. 2d D.C.A. 1985); Lord v. Hodges, 209 So. 2d 692 (Fla. 2d D.C.A. 1968).

(44) Am. Acceptance Corp. v. Schoenthaler, 391 F.2d 64, 73 (5th Cir. 1968) (citing Traver v. Tilton, 134 So. 2d 807 (Fla. 2d D.C.A. 1961)).

(45) Dixon v. Sharp, 276 So. 2d 817, 820 (Fla. 1973).

(46) Fla. Stat. [section] 687.03 (2009).

(47) Stewart v. Nangle, 103 So. 2d 649 (Fla. 2d D.C.A. 1958); see also River Hills, Inc. v. Edwards, 190 So. 2d 415 (Fla. 2d D.C.A. 1966).

(48) See Fla. Stat. [section] 687.04 (2009).

(49) Oregrund Ltd. P'ship v. Sheive, 873 So. 2d 451, 455 (Fla. 5th D.C.A. 2004).

(50) Rebman v. Flagship First Nat'l Bank, 472 So. 2d 1360, 1364 (Fla. 2d D.C.A. 1985); River Hills, Inc. v. Edwards, 190 So. 2d 415, 423-24 (Fla. 2d D.C.A. 1966).

(51) Kraft v. Mason, 668 So. 2d 679 (Fla. 4th D.C.A. 1996); Dixon v. Sharp, 276 So. 2d 817 (Fla. 1973); Am. Acceptance Corp. v. Shoenthaler, 391 F.2d 64 (5th Cir. 1968).

(52) Naples Cay Dev. Corp. v. Ferris, 555 So. 2d 1272 (Fla. 2d D.C.A. 1985); Rebman v. Flagship First Nat'l Bank of Highlands County, 472 So. 2d 1360 (Fla. 2d D.C.A. 1985). See also Lord v. Hodge, 209 So. 2d 692 (Fla. 2d D.C.A. 1968) (granting motion for directed verdict on usury claim where plaintiff failed to present evidence of the lender's corrupt intent).

(53) Earle Lee Butler, P.A. v. Target, Inc., 601 So. 2d 1276 (Fla. 4th D.C.A. 1992). Allowing a jury to hear a baseless usury allegation will unfairly prejudice the lender given the powerful effect on the listener from negative common definitions. Id.

Daniel W. Matlow is a partner in the Ft. Lauderdale office of Ruden McClosky, P.A. Matlow is a member of the firm's litigation department. He received his Bachelor of Arts in economics from the University of Michigan and his J.D. from the University of Miami School of Law, where he was an editor of the Inter-American Law Review.

Jamie B. Wasserman is an associate in the Ft. Lauderdale office of Ruden McClosky, P.A. Wasserman is a member of the firm's litigation department. She received her Bachelor of Arts in communication arts from the University of Wisconsin and her J.D. from Nova Southeastern University, where she was an associate editor of the Nova Law Review.
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Title Annotation:Florida
Author:Matlow, Daniel W.; Wasserman, Jamie B.
Publication:Florida Bar Journal
Date:Apr 1, 2010
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