Under Michigan usury law, the interest rate on a loan may not exceed 7%. If a lender attempts to insert a provision that allows for an interest rate of more than 7%, the debtor may assert a “usury defense.” The usury defense allows a debtor to avoid paying any interest if an illegal interest rate is imposed (i.e. more than 7%), as opposed to reforming the contract and reducing the interest rate on the loan. The harsh result of the usury defense on the lender is intended to curb unscrupulous business practices where a lender could impose an illegal interest rate and, if discovered, would simply reduce the interest rate to a legal rate or, if left undiscovered, be entitled to recover under the illegal interest rate.
However, the Court of Appeals recently upheld an illegal interest rate where it found that both of the parties agreed to the illegal interest rate and the debtor delayed in attempting to bring a usury defense. In Fitzgerald v. Oehmke, No. 333116, 2018 Mich. App. LEXIS 1806 (April 24, 2018), the COA evaluated whether the lower court could reform a note which violated Michigan’s usury laws. In this case, Plaintiff Fitzgerald loaned $20,000 to Defendant Oehmke at an 8% interest rate. Defendant Oehmke needed the money because of a prison stay, and drafted the note bearing his agreement to the terms of the loan. After his release from prison, Oehmke failed to make any payments towards the loan, and cut off contact from Fitzgerald. In response, Fitzgerald sued for a breach of contract.
After some delay, Oehmke attempted to assert the “usury defense”, claiming that the 8% interest rate is illegal and that he should therefore not have to pay any interest on the loan. In response, Fitzgerald requested that the note be reformed to reflect a lawful interest rate of 7%, instead of 8%. The lower court reformed the note in question to bear an interest rate of 7% in compliance with existing Michigan usury law, making the defense of usury moot because the interest rate was now lawful.
The COA found that this reformation of the note was beyond the court’s discretion. Both parties’ intent to be bound by the usurious note constituted a subsequent bar from reformation at the hands of the court. The COA repeated its concern that allowing the court to reform notes in litigation could encourage unscrupulous business practices by both the lender and the debtor. Specifically, in this case, the COA relied heavily on the fact that the debtor had drafted the note and the provision regarding the 8% interest rate. The COA noted that the debtor may have knowingly agreed to the 8% interest rate so he could later assert a usury defense and avoid paying any interest at all.
This article was written by Nezar Habhab, Law Clerk.
Michigan Courts May Not Reform Illegal Interest Rate In Loan Contract Where Agreed to By Parties
