In its opinion released on August 13, 2018, the California Supreme Court answered a question certified by the Ninth Circuit Court of Appeals: “Can the interest rate on consumer loans of $2,500 or more render the loans unconscionable under section 22302 of the Financial Code?” The California Supreme Court answered with an unequivocal “Yes” because an interest rate is price term, and a price term may be unconscionable just like any other term of a contract.
This case began in the Northern District of California when the plaintiffs filed a class action against CashCall, a payday lender, for allegedly violating California’s Unfair Competition Law (the UCL) which prohibits any unlawful, unfair, or fraudulent business act. They argued that the interest rates charged by CashCall, which were 96% and 135% per annum on two of its products, were unconscionable and therefore unlawful. The district court certified the class action and defined the class “as those borrowers who took out loans from CashCall of at least $2,500 at an interest rate of 90% or higher” for personal, family, or household use.
After substantial motion practice, the district court granted CashCall’s motion for summary judgment saying that California’s legislature decided not to limit the interest on consumer loans of $2,500or more, and a ruling that an interest rate could be unconscionable would improperly intrude on the Legislature’s power. The plaintiffs appealed. That led to the Ninth Circuit certifying the question to the California Supreme Court.
The California Supreme Court said the doctrine of unconscionability reaches contract terms relating to the price of goods or services, and the question of whether a price is unreasonably or unexpectedly harsh depends on not only the price, but the other provisions and circumstances affecting the transaction. It noted that unconscionability “is a flexible standard in which the court looks not only at the complained-of term but also at the process by which the contractual parties arrived at the agreement and the larger context surrounding the contract, including its commercial setting, purpose and effect.” In the end, the Supreme Court held that California courts have the authority to decide whether contract provisions, including interest rates, are unconscionable and that an interest rate may render loans unconscionable, and an unconscionable loan may be unlawful pursuant to the UCL.
This decision threatens to throw the consumer loan market and collection industry in California into turmoil. Subprime lenders may have to consider the risk of pricing a loan high enough to make their businesses profitable against the risk of a court finding that an interest rate is unconscionably high. Moreover, when creditors or debt collectors attempt to collect debts, debtors may have an easy method of staving off collection efforts by claiming that the interest rate is unconscionably high. Because the Court found that the question of unconscionability of interest rates is fact specific, courts will be required to wait until trial to make the factual determinations required by the unconscionability defense. If debtors use this defense, obtaining relief on summary judgment may become nearly impossible and increase the risk and costs of collection.
The uncertainty and increased risk created by this decision calls out for a legislative fix—whether that is through an amendment that removes the language in the code that the California Supreme Court considered or an amendment that caps the interest rate used with consumer loans greater than $2,500. Until then, creditors and collectors will be at the mercy of California’s courts whenever debtors assert an unconscionability defense.