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Court of Appeal, Second District, Division 2, California.

John A. McCONNELL and Marguerite McConnell, Individually and on Behalf of All Others Similarly Situated, Plaintiffs, Appellants, and Respondents, v. MERRILL LYNCH, PIERCE, FENNER & SMITH, INC., a corporation, Defendants, Respondents, and Cross-Appellants.

Civ. 48982.

Decided: March 30, 1977

MacDonald, Halsted & Laybourne, Peter Brown Dolan, and Joel Mark, Los Angeles, for cross-appellants. Marcus E. Crahan, Jr., and Jack D. Scott, Los Angeles, for respondents.

John and Marguerite McConnell, suing individually and on behalf of all others similarly situated, sued Merrill Lynch, Pierce, Fenner & Smith, Inc., for charging illegal compound interest and interest amounting to more than 10 percent as to their margin account customers. The alleged class is ‘composed of all of the customers of defendant's California offices who are residents of and have mailing addresses in the State of California and who maintained margin accounts with defendant during the period beginning November 26, 1971, and ending September 26, 1973, and who were charged interest by defendant during said period in violation of the laws of the State of California relating to usury, including section 22 of Article XX of the California Constitution, and sections 1916–1 through 1916–5, inclusive, of the California Civil Code.'* Plaintiffs prayed for recovery of interest charged during said period in violation of the usury laws, interest thereon, and treble damages. They also ask for forfeiture of all such interest charged or paid and for a declaration of their rights.

Defendant filed a demurrer alleging that the first and second causes of action (alleging compound interest and treble damages thereon) fail to state a cause of action and are barred by the statute of limitations. Defendant further filed a motion to strike various paragraphs of the second amended complaint that alleged treble damages, contending that such treble damages are not amenable to class action treatment. Prior to the filing of the second amended complaint, plaintiffs had filed a motion to determine certain class issues. This motion, however, was based on the first complaint for damages, which did not specifically allege compound interest as a cause of action. Various answers to interrogatories and memoranda in support of and opposition to the motion to determine certain class issues are part of the record on appeal.

Pursuant to stipulation, the trial court considered the demurrer as a motion for partial summary judgment and made various findings. The court found that plaintiffs are members of the class alleged in the first and second causes of action (compounding causes of action); that the third and fourth causes of action re charges of excess interest do not constitute a class such as is alleged, but would be a smaller class of which the McConnells are not members; and as to the fifth cause of action for declaratory relief, the McConnells are not bound by the New York choice of law provision. Otherwise, they probably are able to represent the class so far as the cause of action for declaratory relief goes. As to the motion to determine class issues, the court made further findings: regarding the class defined in the complaint, the court found that such class could not be certified because, even assuming that all defendant's open margin account customers were charged interest at a rate in excess of 10 percent during the period from July 5, 1973, to September 26, 1973, Article XX, section 22, of the California Constitution is not violated unless the total charges, when averaged out for the entire period of the loan, exceed an effective rate of 10 percent per annum.

The court further found that the class was composed of two sub-classes, including those whose agreement had an express choice of law designation favoring New York and those that were not so designated. The court did find, however, that if plaintiffs' class existed, it would present questions of law and fact predominantly common and would permit the use of the class action procedure, with the exception of awarding treble damages. Plaintiffs John and Marguerite McConnell were found to be members only of the ‘pre-1967’ sub-class because they did not execute a margin account agreement containing an express New York choice of law provision. Because of this, the trial court found that the individual plaintiffs could not properly represent the entire plaintiffs' class but only one sub-class. As for compounding of interest, the court found that the ‘customer's agreement’ considered by itself sufficiently evidences a written and signed agreement calling for the compounding of interest so as to comply with Civil Code section 1916–2.

The court ordered points 1 and 2 of the demurrer (alleging no cause of action as to the compounding and treble damages thereon) sustained without leave to amend and, along with so much of the fifth cause of action that speaks to the alleged violation of Civil Code section 1916–2, to be dismissed. ‘This action and plaintiffs' Second Amended Complaint are dismissed without prejudice as a class action. . . . This action and Plaintiffs' Second Amended Complaint are dismissed as to the individual claims of John A. McConnell and Marguerite McConnell.'1

Plaintiffs and defendant appeal from various portions of the court's order.2


Plaintiffs have been margin account customers of defendant since 1966. Plaintiffs allege that defendant has charged compound interest without a written agreement so specifying and has charged interest in excess of 10 percent in violation of California usury laws. The section of the lending agreement that concerns compound interest reads as follows:

‘The monthly debit balance in my account(s) shall be charged, in accordance with your usual custom with interest at a rate which shall include the average rate paid by you on your general loans during the period covered by such balances respectively, and any extra rates caused by market stringency, together with a charge to cover your credit service and facilities.’

The trial court's order stated that all counsel had agreed that ‘in deciding the Demurrer to the Second Amended Complaint the Court could thereby make a determination as to whether or not the subject ‘Customers Agreement’, attached as Exhibit ‘A’ to the Second Amended Complaint, standing alone and not in conjunction with any other evidence that may have been previously admitted, complied with the requirements of Civil Code § 1916–2; . . .'

As for the allegations of excess interest, the answers to interrogatories by Merrill Lynch reveal the base rate it pays commercial lenders for brokerage loans as well as the service charge it adds to this base rate in charging its margin account customers. The base rate ranged from 6 percent on January 1, 1973, to 10 percent on September 4, 1973. The service charge ranged from 1 percent for daily debit balances of over $50,000 to 1 1/2 percent for daily debit balances of below $10,000. In answer to still another interrogatory, Merrill Lynch conceded that the interest charged was in effect a loan.3 The total ‘interest’ and/or ‘service’ charges by defendant on the debit balances to the margin accounts maintained by its California customers during the period July 5, 1973, to September 26, 1973, was in excess of 10 percent, the limit allowed under the provisions of Article XX, section 22, of the California Constitution.

In addition, the ‘year’ in which interest is charged is a 360-day basis rather than a 365-day basis. Merrill Lynch contends that no customer has paid interest of more than 10 percent on an annualized basis.


The many and lengthy contentions of the parties on appeal and cross-appeal boil down to basically three questions:

1. Was there a sufficiently express written contract to allow the charging of compound interest?

2. Is the computation of interest to be determined by ‘averaging’ on an annual or total period basis or is computation limited to a shorter period during which the amount of interest for that period exceeded the lawful rate?

3. Is there a genuine class which plaintiffs can adequately represent?


1. The customer's agreement was sufficiently clear regarding compound interest to comply with the requirements of Civil Code section 1916–2.

Civil Code section 1916–2 provides in part:

‘. . . in the computation of interest upon any bond, note, or other instrument or agreement, interest shall not be compounded, nor shall the interest thereon be construed to bear interest unless an agreement to that effect is clearly expressed in writing and signed by the party to be charged therewith. . . .’

The McConnells contend that Merrill Lynch's customer's agreement does not contain said clear expression and that the charging of compound interest was illegal. The trial court found that the customer's agreement did sufficiently evidence a written and signed agreement calling for the compound of interest so as to comply with section 1916–2.

The section in the lending agreement, quoted above contains nothing as clear as the provisions in Heald v. Friis-Hansen, 52 Cal.2d 834, 345 P.2d 457, and Penzner v. Foster, 170 Cal.App.2d 106, 108, 338 P.2d 533. The agreements in those cases, which were held not to be usurious with respect to compounding interest, provided that the interest not paid shall become part of the principal and thereafter bear like interest. On its face, the agreement in the instant case did not ‘clearly express' that interest would be compounded. Rather, the provision stated that the monthly debit balance would be charged ‘in accordance with your usual custom . . ..’ We disagree with the trial court's ruling that compliance with section 1916–2 is evident within the four corners of the document. However, any ambiguity in the language ‘your usual custom’ must be resolved against the McConnells. They had had many years of previous transactions with defendant Merrill Lynch based on similar agreements. Therefore, they knew that ‘your usual custom’ included the charging of compound interest.

Moreover, the defendant had provided to all of its margin customers the booklet ‘What is Margin’ which clearly explained the compounding of interest on the credit advances made to its margin customers. Therefore, the McConnells knew that ‘your usual custom’ included the charging of compound interest. The fact that at plaintiffs' specific request the trial court announced that it decided the demurrer and ordered it sustained solely upon the actual wording of the customer's agreement itself is not controlling. Plaintiffs and defendant had stipulated at the outset of the hearing upon the demurrers that the court should treat the matter as a motion for summary judgment. The court thus had properly before it at this point additional information and documentation from such items as answers to interrogatories and other pleadings, that clearly demonstrated the sufficiency of the contract. The trial court and this court should not be blind to the true facts that would sustain the summary judgment, simply because plaintiffs in midstream of the hearing, sought to change the effect of their stipulation and sought to force an academic ruling on the meaning of the single phrase ‘your usual custom’ without reference to anything else. That tactic would be wasteful of judicial time and simply result in another round of procedure. We therefore ignore the attempted limitation and the announced limitation by the trial court that the only fact before it was the document itself. Additionally, what was said by then Presiding Justice Peters in Brown v. Cardoza, 67 Cal.App.2d 187, 153 P.2d 767, a similar case involving the same statute, Civil Code section 1916, is apposite.

‘We have grave doubts that, if a transaction is not usurious, so far as the interest charge is concerned, the portions of sections 1 and 2 above quoted were ever intended to render void all interest provisions if perchance the agreement to pay more than 7 per cent is not clearly expressed, or if interest is charged on interest without a clear agreement to that effect. The two portions of the sections quoted seem to embody a rule of construing ambiguous documents, rather than compelling a court to void all interest simply because the contract may be ambiguous. . . .’ (67 Cal.App.2d at p. 194, 153 P.2d at p. 770.)

We agree with the trial court that there has been no illegal compounding of interest in violation of section 1916–2. Since we find no violation of usury in this regard, we find the trial court correctly decided to sustain portions of the demurrer (or partial summary judgment) alleging no cause of action as to the compounding of interest and trevle damages thereon.

2. The charging of excess interest.

The trial court found that the provision proscribing interest in excess of 10 percent per annum is not violated unless the total charges, when averaged out for the entire period of the loan, exceed an effective rate of 10 percent per annum.4 The court defined its own class of margin customers to whom such interest was charged, but found that the McConnells were not part of such class and dismissed the second amended complaint as to the individual claims of the McConnells. Merrill Lynch agrees with the trial court's annualization requirement and argues that one cannot isolate the interest charged during three months from a loan that spread out over nine years. The McConnells, on the other hand, argue that the Legislature could have provided for the ‘average annual interest’ rather than interest ‘per annum’ if that is what was intended. They further contend that the monthly charge period provides all of the outside parameters for both computations and charging of interest.

We agree with the trial court that the interest must be spread over the entire period of the loan, not considered in month-by-month installments. However, the unique nature of the margin loan transaction creates complications in determining exactly what is the term of the loan. Is it the entire period of the open margin account, as alleged by Merrill Lynch? Or are there a series of shorter terms, based on when different stock transactions begin and end (i. e., the term would be from the date of purchase to the date of sale)? The nature of the margin account is open-ended. Customers in such accounts are continuously borrowing money. Given the nature of such accounts, the term over which interest must be calculated is that of the entire period of the loan. (Cf. Arneill Ranch v. Petit, 64 Cal.App.3d 277, 289–293, 134 Cal.Rptr. 456.) Therefore, we agree with the trial court that neither the McConnells nor the plaintiffs' class that was set forth in the second amended complaint has stated causes of action for excess interest.5

Merrill Lynch further contends, assuming that usurious interest was charged, there must be actual payment of the usurious interest for a cause of action to accrue. Reliance is placed on Ewell v. Daggs, 108 U.S. 143, 2 S.Ct. 408, 27 L.Ed. 682, and Westman v. Dye, 214 Cal. 28, 38–39, 4 P.2d 134. Merrill Lynch contends that there is no evidence that plaintiffs had paid any interest to defendants, certainly not prior to September 26, 1973.

For the borrower to recover treble damages for usury, there must have been payment in excess of the amount allowed. (Civ.Code, § 1916–3; Heald v. Friis-Hansen, supra, 52 Cal.2d at p. 839, 345 P.2d 457.) The court in Penziner v. West American Finance Co., 10 Cal.2d 160, 179, 74 P.2d 252, 261, stated: ‘It is only when there has been an actual payment of usurious interest that the one receiving such interest is held to have violated the terms of the Usury Law and accordingly held liable for the penalties thereby imposed. [Citations.]’ In accord is Domarad v. Fisher & Burke, Inc., 270 Cal.App.2d 543, 560, 76 Cal.Rptr. 529, 540, which states that ‘A transaction is not usurious, so as to require the lender to refund usurious interest received by him until there has been an actual payment of usurious interest. [Citations.]’

We have reviewed the second amended complaint. Nowhere do plaintiffs allege that they have actually paid usurious interest to defendants. Rather, they allege that such interest has been ‘computed’ and ‘charged.’ These allegations are insufficient to establish a cause of action.

3. The class action.

The McConnells contend that they are proper class representatives of the classes they seek to have certified, that a cause of action for recovery of the statutory penalty for treble damages has been alleged, and that the class action remedy is appropriate. The trial court found that McConnells were part of the pre-1967 sub-class that did not contain an express New York choice of law provision and, therefore, could not properly represent the entire plaintiffs' class but only that sub-class.

As stated above, there is no allegation in the second amended complaint that payment of excess interest was made either by the individual or the class plaintiffs. Therefore, we cannot say that there is any individual or class action that can be based either on the compounding of interest or possible excess interest when no payment of such was made to defendant Merrill Lynch. Because of this resolution of the class action issue, we find it unnecessary to review the claims of the inadequacy of plaintiffs' representation of the class or the court's advisory remarks regarding establishment of the ‘court's class.'6

The dismissals of the trial court are affirmed. Respondent-Cross-Appellant Merrill Lynch to recover costs on appeal.


FOOTNOTE.  The parties and the court below have referred to section 1916–1 et seq. of the Civil Code. The Usury Law is an initiative measure (Stats. 1919, pp. lxxxiii–lxxxiv) and not a legislative codification. However, the Usury Law has been incorporated into code compilations (Deerings Ann.Uncod.Measures 1919–1 (1973 ed.) p. 35; 10 West's Ann.Civ.Code (1954 ed.) foll. § 1916 at p. 123), and code section numbers have unofficially been assigned by the publishers simply as a convenience. While recognizing that such designation by code section is unofficial, we have cited the references of the trial court and counsel and have therefore employed the code section designations as an editorial convenience in this case.

1.  In the same order, the court defined the ‘court's class' as being made up only of those margin customers of defendant who opened accounts ‘after a date far enough prior to September 26, 1973 so that the margin loan interest charged them between the date they opened their accounts and September 26, 1973, when averaged out for the entire length of the loan, would have been in excess of ten percent per annum for that period.’ As to its class, the court found that there are predominantly issues of fact and law that would permit the use of the class action procedure, again with the exception of the question of treble damages. The court found that the named plaintiffs are not members of the court's class because they opened their account prior to the opening date referred to above and therefore could not fairly and adequately protect the interest of the court's class. The September 26, 1973, date is important because on that date Merrill Lynch secured a license as a personal property broker in California as defined in Division 9 of the California Financial Code in accordance with Chapter 713 of the California Statutes of 1973, which exempted defendants from the 10 percent interest ceiling.

2.  Defendant appeals, inter alia, from the court's ruling on points 3 and 4 of the demurrer. However, since the ruling by stipulation was one as upon a request for summary judgment, it may be reviewed here upon appeal. On the other hand, since the ‘overruling’ was ‘without limitation upon raising the affirmative defense of the applicable statute of limitations by way of an answer,’ defendant is hardly prejudiced by this ruling.

3.  At times on appeal, Merrill Lynch has disputed that this interest was a loan.

4.  Article XX, section 22, of the California Constitution was superseded in June 1976 by Article XV, section 1. That section provides in part:‘No person, association, copartnership or corporation shall by charging any fee, bonus, commission, discount or other compensation receive from a borrower more than 10 percent per annum upon any loan or forbearance of any money, goods or things in action.’

5.  The McConnells further contend that Merrill Lynch has violated the usury law regarding excess interest even if ‘per annum’ is construed to require charging of an average annual rate in excess of 10 percent. However, their argument proceeds that an average annual rate of interest in excess of 10 percent was charged for the billing periods ending August 31 and September 28, 1973. This is not the same as saying that the interest per annum charged over the entire period of the loan is in excess of 10 percent.

6.  The class hypothesized by the court was also of customers who had been charged margin loan interest between certain dates so that when averaged out they exceeded 10 percent per annum for the period. The mere charging of interest did not provide a basis for relief. As contended by Merrill Lynch, payment of excess interest should have been a prerequisite to participation in the class if any is certified.

BEACH, Associate Justice.

FLEMING, Acting P. J., and COMPTON, J., concur.