Jerome BURR and Maxine Burr, doing business as El Rancho Family Billiard Club, Plaintiffs, Appellants and Respondents, v. CAPITAL RESERVE CORPORATION, Defendant, Respondent, and Appellant.
These are cross-appeals from a judgment, following a nonjury trial, determining inferentially that two leases of certain new business equipment were not in reality usurious secured monetary loan transactions and that a third leaseback of certain used business equipment, formerly belonging to plaintiff, was.1 The ‘interest’ paid by plaintiff to defendant in the amount of $6,105.75 in the third transaction was awarded, without being trebled, to plaintiff, but he was required to credit this award against the balance owing from him to defendant in the second transaction.
In early 1963 plaintiff was the owner of the stock of the Culver City Rink, a California corporation, which operated an ice skating rink. He decided to convert some property he leased on West Pico Boulevard into a family billiard parlor, which was then a new and somewhat speculative form of business enterprise. He selected the necessary carpeting, pool tables, etc., but discovered that he lacked the funds to complete these purchases. He turned to defendant for the necessary financing. Defendant purchased for plaintiff both the carpeting and the pool tables, etc. for $5,417 and $39,060.04, respectively. Defendant then by two written leases, one for three years and the other for five years, executed respectively on May 8, 1963, and May 31, 1963, leased this business equipment to plaintiff for a total rental of $6,825.60 for the carpeting and $52,730.88 for the pool tables, etc.4
Defendant borrowed the money to make these two purchases from the Union Bank at an annual interest rate of 10 percent. The second transaction, which involved the pool tables, illustrates the procedure that defendant followed in all three transactions. In that transaction it borrowed from the bank $34,117.54, or, in other words, the original cost of the equipment less the just-mentioned payment required of plaintiff on the execution of the lease. In return for this loan it executed a note to the bank in the amount of $40,708.62, payable in 46 monthly installments, and, with plaintiff's written consent, assigned as security for the payment of this note its lease to plaintiff, and delivered to the bank a trust receipt covering the leased equipment. In addition, defendant delivered to the bank plaintiff's stock in the previously mentioned ice skating rink which plaintiff had pledged with it for his performance of the two leases. Plaintiff also executed and delivered to the bank a general collateral pledge agreement in favor of the bank covering this stock.
Early in 1964, plaintiff decided to open a second family billiard parlor in another location. To finance this expansion plaintiff needed to sell his stock in the ice skating rink which he had pledged with defendant and then with the bank. The bank indicated that it would release the stock only if plaintiff deposited with it as substitute security $15,000 in a savings account.5 Once again plaintiff turned to defendant to provide him with the necessary sary cash. At defendant's suggestion, in April 1964, plaintiff sold certain of his billiard parlor equipment to defendant for apparently $16,750, and on April 8, 1964, plaintiff and defendant executed a lease of this equipment back from defendant to plaintiff for rentals totaling $20,569 over a two year period. The payment of $1,675 due to defendant from plaintiff on the execution of this lease was not paid by plaintiff but was instead deducted from the amount of cash he received from the sales escrow handled by the bank. Plaintiff received from this escrow $15,075.6
During the negotiations for the third lease there was apparently some discussion between plaintiff and defendant about the granting by defendant to plaintiff of options to purchase all of the equipment which he had leased from defendant. Nothing was forthcoming in this respect, however, until January 1965 when, after the intervention of plaintiff's counsel, purchase options were granted by defendant to plaintiff for $5,585.46 as previously mentioned.
In April 1965, plaintiff stopped making his monthly rental payments under the three leases. After negotiations between his counsel and defendant, the parties agreed on May 26, 1965, that plaintiff might use his money on deposit with the Union Bank to pay the balance of the rentals and the optional purchase prices under the first and third leases to defendant and the second lease would then be transferred by defendant from Union Bank to United California Bank, which would receive from defendant an assignment of the rentals due under that lease. This agreement was fully performed in the early days of June 1965. A few weeks later plaintiff initiated this suit.
Under the Usury Law and Usury Amendment the rate of interest upon a loan of money may not exceed 10 percent per annum.7 In this case, each of the three transactions, if viewed as simply a secured monetary loan, appears to involve a greater interest return than this maximum rate. According to defendant's own memorandum, under the three leases plaintiff was obligated to pay to it in total rentals an excess of $18,898.44 over the cost of the leased equipment to it ($61,227.04).8 In fact, the officer of defendant who negotiated the three leases explained with respect to the first lease that defendant sought a return of three and a half percent per month or 42 percent per year on its investment in the equipment.
This 10 percent ceiling in interest rates applies, however, only to charges for the use of money over a period of time and to nothing else. Defendant contends that the three contracts under review were leases of business equipment and nothing more and were therefore not loans subject to the Usury Law and the Usury Amendment. Plaintiff, on the other hand, asserts that these three leases of business equipment were really disguised secured monetary loans from defendant to plaintiff.
We must, therefore, determine what these three transactions actually were. To do this we must examine all of the circumstances surrounding each transaction to uncover the substance which lies beneath its form. (See Thomas v. Hunt Mfg. Corp., 42 Cal.2d 734, 740, 269 P.2d 12; Milana v. Credit Discount Co., 27 Cal.2d 335, 340–341, 163 P.2d 869, 165 A.L.R. 621.) Whether a particular business transaction is essentially usurious depends on its facts (Giorgi v. Conradi, 199 Cal.App.2d 82, 85, 18 Cal.Rptr. 588) and doubts as to the fundamental nature of a transaction are to be resolved in favor of its legality. (Knoll v. Schleussner, 112 Cal.App.2d 876, 880, 247 P.2d 370.)
Our analysis of the circumstances surrounding these three transactions, as to which there is no significant conflict in the evidence, leads us to conclude that all of them were devices to finance the acquisition of property by the plaintiff, and each involved a secured monetary loan. They do not appear to have been installment sales of business equipment, even in a conditional form, because defendant's options to purchase the leased equipment were not granted to plaintiff at the inceptions of the various transactions but sometime later. Likewise, defendant was neither an investor in plaintiff's family billiard parlor business nor a joint venturer with him in it.
However, it must be remembered that most types of business financing do not come within the Usury Law and the Usury Amendment. The Amendment exempts expressly the main classes of lenders (see Carter v. Seaboard Finance Co., 33 Cal.2d 564, 587, 203 P.2d 758), including banks such as the Union Bank. Incidental, legitimate, specific expenses of loan transactions likewise are not covered. (See Klett v. Security Acceptance Co., 38 Cal.2d 770, 788, 242 P.2d 873.) The usury restrictions also do not apply to deferred payments under contracts for the conditional sale of property so long as these transactions are truly sales transactions and not loan transactions. (Verbeck v. Clymer, 202 Cal. 557, 562–564, 261 P. 1017; Wilson v. J.E. French Co., 214 Cal. 188, 189–190, 4 P.2d 537.)
More significantly, so far as this case is concerned, both of these enactments apply only to charges for the use of money over a period of time and to nothing more.9 Where the lender provides the borrower with something in addition to a loan of money, the charge the lender makes is not subject to the Usury Law and the Usury Amendment. (Klett v. Security Acceptance Co., supra, 38 Cal.2d 770, 776–780, 242 P.2d 873.) This something extra may be the provision of a business advisory service, as was the situation in Charlotte Guyer & Associates v. Franklin Factors, 211 Cal. App.2d 690. 693–695, 27 Cal.Rptr. 575, or it may be remodeling and financing a building, as was the case in Lamb v. Herndon, 97 Cal.App. 193, 199–201, 275 P.503. But the something extra may be providing the borrower with the assistance of the lender's credit. This is what happened in Klett, supra, in Weintraub v. Soronow, 115 Cal. App. 145, 151,1 P.2d 28, and in Orlando v. Berns,10 154 Cal.App.2d 753, 755–759, 316 P. 2d 705. This is what also occurred in this case.
By resort to this equipment leasing device plaintiff was provided in the first two transactions with over 85 percent of the cost of the new equipment he thereby acquired for his new business.11 In the third transaction, plaintiff was enabled to obtain the $15,000 net he needed to get the pledged stock released by the bank by selling to defendant and immediately leasing back from defendant, for the apparent price of $16,750, his own equipment. In this transaction he obtained in cash 90 percent of the apparent market value of this used equipment. If he had borrowed directly upon this same equipment by mortgaging it, he could have obtained a maximum loan of only one-third of its market value and if he had used conditional sales contract financing he could have obtained a maximum loan of between one-half and two-thirds of its market value.12 This advantage of leaseback financing was explained in detail to plaintiff by an officer of defendant before the third transaction was entered into between the parties.13
Defendant, in all three transactions, with plaintiff's knowledge, and as an integral part of each transaction, borrowed the funds it loaned plaintiff by means of these equipment leases from the Union Bank on its own installment note at a rate of 10 percent annual interest, secured by the security it obtained from plaintiff, the leases and the leased equipment. The something extra that defendant provided plaintiff in each transaction was the assistance of defendant's credit in obtaining the necessary funds from the bank, which enabled plaintiff to obtain a loan of a much higher proportion of the market value of the equipment than he could have otherwise obtained directly. This meant that in the first two transactions plaintiff was able to acquire far more new equipment than he otherwise would have been able to purchase with the working capital he used, and in the third transaction he was able to tie up much less of his equipment for loan purposes than he would otherwise have been required to do. In all three situations, by the use of this much more costly type of financing, plaintiff was able to retain in his business more working capital.
In actuality then, these three transactions were not two-party but three-party transactions. The source of the money loaned in each of them was the Union Bank, an exempt lender under the Usury Amendment. By virtue of equipment leases with defendant and by resort to the assistance of defendant's credit with the bank plaintiff was enabled to obtain indirectly from the bank at a greater cost much larger loans for new equipment and on used equipment than he otherwise would have obtained.
On the nonconflicting evidence before us we cannot agree with the trial court's determination that the third transaction, unlike the first two, was subject to the Usury Law and the Usury Amendment. It differed from the first two transactions only in these respects: (1) used equipment belonging to the plaintiff rather than new equipment which he had never owned was involved; (2) this transaction included a sale and immediate leaseback instead of simply a lease of new equipment; and (3) in the first two transactions the money defendant obtained by its loans from the bank and from plaintiff's payments on execution of the leases went directly from defendant to the suppliers of the new equipment, while in the third transaction such money went into a sales escrow for the benefit of plaintiff.
These differences and the irregularities in the transaction, which we have mentioned, do not, in our opinion, affect the fundamental tripartite structure of all three transactions. As we have stated, in each transaction more money was made available to plaintiff from the bank for equipment or on equipment through the interposition of defendant's credit with the bank than otherwise would have been the case. It is this assistance of defendant's credit which is the something extra which takes the third transaction, as well as the first two, outside of the Usury Law and the Usury Amendment. (Cf. Klett v. Security Acceptance Co., supra, 38 Cal.2d 770, 776, 203 P.2d 758.)
We have not discussed plaintiff's contention that it was prejudicial error for the trial court to exclude testimony of certain conversations between two specified brokers and the plaintiff on the ground that the requisite agency relationship be tween them and defendant had not been established. Apparently, plaintiff was offering the excluded testimony in an effort to prove that he was entitled to bills of sale from the defendant for the leased equipment on payment of the total rentals due without making, in addition, the optional purchase price payments. Since plaintiff has never indicated at any time the substance of these conversations, we cannot say that their exclusion constituted prejudicial error even if we assume, for the sake of argument only, that such exclusion was error. (See Evid.Code, § 354.)
Defendant has not challenged that portion of the judgment ordering it to convey title to the equipment leased in the second transaction upon full compliance by the plaintiff with the terms of the applicable lease and the payment of the optional purchase option price as well. Likewise, it has not challenged that portion of the judgment declaring plaintiff to be presently the owner of the equipment leased to him in the first and third transactions.
The judgment is reversed with directions to the trial court to revise its findings of fact and conclusions of law and enter judgment consistent with the views expressed in this opinion.
1. The plaintiffs Burr for convenience will be referred to in the singular and in the masculine gender. The defendant is a California corporation.
2. Stats.1919, p. lxxxiii, initiative measure approved November 5, 1918, Deering's General Laws, 1954, Act 3757 [West's Ann.Civ.Code, § 1916–1 et seq.].
3. California Constitution, art. XX, 2nd § 22, adopted November 6, 1934.
4. These total rentals included the payments ($568.80 and $4,942.50) required of plaintiff upon the execution of these two leases, but they do not include the prices under the purchase options granted plaintiff later which were exercisable upon full payment of the rentals due under the leases. These purchase price options for all three transactions amounted to $5,585.–46.These optional purchase prices normally represented the residual or salvage value of the leased equipment after such equipment had been fully depreciated by defendant. They usually ran between 10 and 20 percent of original cost. However, in both the first and third transactions they amounted exactly to three monthly rentals under the leases.
5. This background was fully developed at oral argument.
6. Apparently plaintiff submitted to defendant an itemized list of equipment with plaintiff's estimate of the market value of each item. From this list, after appraising the market value of the various pieces of equipment, defendant chose that equipment which it would buy from plaintiff for the apparent price of $16,750 and immediately leased it back to plaintiff.There were several irregularities with respect to this sale and immediate leaseback transaction. As already indicated, unlike the other two transactions, the payment due on execution of the lease was not actually made by plaintiff to defendant. The $75 in excess of $15,000 which the plaintiff received in escrow from the defendant was apparently paid so that plaintiff could cover the expenses of the sale which he assumed. Finally, the lease of this used equipment, formerly owned by the plaintiff, appears to have been executed before the sale was made.
7. This maximum rate of 10 percent is found in the Usury Amendment; it supersedes the prior maximum rate of 12 percent found in the Usury Law. (Heald v. Friis-Hansen, 52 Cal.2d 834, 838, 345 P.2d 457.)
8. This excess was labeled ‘Interest charges' in defendant's own memorandum. It works out to a gross return of approximately 31 percent return on the original cost over the terms of the three leases.
9. This conclusion is consistent with the statutory definitions of a loan of money and of interest. (See Civ.Code, §§ 1912, 1915.)
FN10. This case is, however, not authority for this proposition in that the $145,000 loan there obtained by the lender from an insurance company was simply taken into account in the overall loan the lender made to its borrower in determining whether the interest charged by such lender was usurious. It apparently was not.. FN10. This case is, however, not authority for this proposition in that the $145,000 loan there obtained by the lender from an insurance company was simply taken into account in the overall loan the lender made to its borrower in determining whether the interest charged by such lender was usurious. It apparently was not.
11. This figure is obtained by comparing the cost of the new equipment and the payments required of plaintiff by defendant upon the execution of the two leases. In Klett, supra, 38 Cal.2d at pp. 779–780 242 P.2d 873, the defendant finance company advanced the plaintiff 90 percent of the wholesale price of the furniture it ‘floored’ with plaintiff.
12. For confirmation generally of this advantage of lease financing over chattel mortgage and conditional sales contract financing see McGraw & Greenblatt, Lease Financing of Capital Equipment and Machinery by Business (1961) 32 Okla.Bar Assoc.J. 1777, 1785.
13. Apparently, the reason defendant could profitably afford to make a much higher proportion of the market value of the equipment available for loan purposes, aside from its much higher rate of return on the loan, was because by means of the lease device it obtained for income tax purposes a depreciation deduction to apply against its rental income. The principal hazard of the device in this area is that for income tax purposes it may be treated as a conditional sale. (See Note (1964) 44 Boston Univ. L.R. 103.) As previously indicated, payments under a conditional sales contract do not come within either the Usury Law or the Usury Amendment.
FORD, P. J., and MOSS, J., concur.