Winn v. Chateau Cantrell Apartment Co.

David Newbern, Justice.

This is a usury case. James A. Winn and Juanita B. Winn, the appellants, sold an apartment complex to appellee Chateau Cantrell Apartment Company (Chateau Cantrell), a general partnership, for $2,300,000, taking in return a promissory note for $1,600,000 which was secured by a mortgage.

Chateau Cantrell sold the property to Chateau Residential Partnership (Chateau Residential), through its nominee E. Ralph Cotham IV, which in turn executed a deed of trust in favor of appellee Charles T. Tuggle, Jr., trustee, and appellee First Tennessee Bank. The deed of trust provided an assignment to Chateau Cantrell of rents and profits from the complex as security. Chateau Residential also assigned rents and profits as security for its obligation to the bank. Cotham subsequently purchased the interests of the other Chateau Residential partners who took a mortgage from him to secure payment. Also joining as appellees are Mrs. E. Ralph Cotham IV, Mr. and Mrs. James R. Bearden, and Mrs. John W. Joyce, Mr. and Mrs. John E. Slayden, and Mr. and Mrs. Henry A. Lile. The Beardens, Joyces, and Liles are Mr. Cotham’s mortgagees. Mrs. Cotham was named a defendant on the assertion that the Winns’ interest is superior to her dower interest.

Our concern here is with a usury defense raised by Chateau Cantrell to a suit to foreclose the mortgage brought by the Winns. Payments were made on the original note from Chateau Cantrell to the Winns until 1988. When the payments to the Winns ceased, they sought foreclosure. The note from Chateau Cantrell to the Winns was to bear interest at 10 % per annum from November 1, 1982, until paid. The payment clause, however, contained a compounding formula which the chancellor concluded made the interest rate usurious under Ark. Const., art. 19, § 13. The note was executed prior to the adoption of Amendment 60 which eliminated the constitutional flat 10% interest cap. The court also found that the transaction was not “a loan for business purposes” and thus the interest rate was not made legitimate by § 511 of the Depository Institution Deregulation and Monetary Control Act of 1980, 12 U.S.C.S. § 86a, which would have preempted the Arkansas law.

The Winns raise six issues on appeal. We agree with their first contention that it was error for the chancellor to hold that the transaction was not one falling within the preemption contained in § 511. We, therefore, need not consider their second contention which is that the note was not usurious under the 1982 Arkansas law. We also need not consider their third point which has to do with whether the mortgage in favor of the bank was a breach of a clause in Chateau Cantrell’s mortgage to the Winns providing against further mortgages. As the mortgage in favor of the Winns takes precedence over the later ones, the trial court on remand will have to determine the extent to which the bank must reimburse the Winns for rents and profits which the bank received. The fifth point argues that the court erred in not continuing a receivership for the rents and profits from the apartment complex during the appeal. It is now moot. Lastly, the Winns contend they were erroneously denied attorney fees. Upon remand the trial court will have an opportunity to reconsider that question in light of this decision.

1. The partnership’s note

Chateau Cantrell was a general partnership organized for the purpose of owning the apartment complex. The note and mortgage were prepared by counsel for Mr. John Flake and Flake and Company. Mr. Flake testified he was the managing general partner, and the other partners included “two physicians . . ., two or three businessmen, a financial institution service corporation was involved, as well.” Flake and Company was not a partner but was hired by Mr. Flake, acting for the partnership, to manage the apartment complex. The other partners, according to Flake’s testimony, were “there for investment and tax benefits,” and were not to take an active role in managing the property.

The note bears Mr. Flake’s signature and contains this language:

The maker [Chateau Cantrell] acknowledges and represents to the holders [the Winns] that the proceeds of the loan evidenced hereby shall be used solely for a business or agricultural purpose within the meaning of the Depository Institutions Deregulation and Monetary Control Act of 1980 and specifically Sections 511 and 512, Part B: business and agricultural loans, same as being public law 96-211, March 31, 1980, 94 Stat. 164, which law shall govern and control all issues involving all interest charged on the loan proceeds.

The lawyer who prepared the note on behalf of the partnership testified that he inserted that clause because he felt the interest specified might make the loan usurious under the Arkansas law, and he felt as a matter of “fact” the loan was being made for business purposes.

2. The preempting federal law

Section 511 provides:

If the applicable rate prescribed in this section exceeds the rate a person would be permitted to charge in the absence of this section, such person may in the case of a business or agricultural loan in the amount of $ 1,000 or more, notwithstanding any State constitution or statute which is hereby preempted for the purposes of this section, take, receive, reserve, and charge on any such loan, interest at a rate not more than 5 percent per centum in excess of the discount rate, including any surcharge thereon, on 90-day commercial paper in effect at the Federal Reserve bank in the Federal Reserve district where the person is located.

The appellees do not argue that the rate specified in the note to the Winns exceeded that allowed by this language of § 511. They do urge us to accept the trial court’s conclusion that the loan evidenced by the note was not a “business loan” as contemplated by the statute. The Winns argue it is a business loan either as a matter of law or as a matter of fact. The appellees argue that the issue is one of fact and that the chancellor cannot be shown to have been clearly erroneous in deciding that the loan was not one for business purposes as contemplated by § 511.

The Winns cite a number of cases from other jurisdictions, none of which is quite on point. We are asked to infer, for example, that a mortgage loan can be a business loan from the holding in Union National Bank of Laredo v. Nelson, 747 F.2d 310 (5th Cir. 1984), that a mortgage loan was a “variable rate loan” covered by § 511 because it applied to such loans made before the current law came into effect. There was no issue as to whether the loan was a business loan. Even if a mortgage loan can be a business loan, that does not help in deciding whether the mortgage loan in this case is a business loan. Explanation as to how each of the cited foreign cases is not quite on point would not be helpful and would unduly prolong this opinion.

The Winns’ strongest citation is Briggs v. Capital Savings & Loan Ass’n, 268 Ark. 527, 597 S.W.2d 600 (1980), which was decided under the predecessor to the current §511. Briggs was asked to participate with others in developing land Worsham had purchased and mortgaged to Capital Savings & Loan. The development plans fell through. Worsham could not make a loan payment to Capital, so Briggs loaned Worsham $6,250 to make the payment but noted on the check that it was “advance on purchase.” Subsequently Worsham needed $150,000 to keep from losing the property. In order to loan Worsham this additional amount, Briggs borrowed $110,000 from Capital, using other property Briggs owned as security. A usury question arose, and the issue became whether the loan from Capital to Briggs was a business loan and thus not subject to the Arkansas usury limit because of the federal preemption.

Briggs contended he used the money from Capital to lend to Worsham just to help Worsham as a friend, but the loan application Briggs had filed with Capital contained these inserts: “commercial loan” and “cash to purchase property.” In addition, Briggs had signed an affidavit to the effect that he understood the loan was a business loan within the meaning of the federal law permitting interest in excess of the maximum non-usurious interest which was 10%.

In affirming the trial court’s holding in favor of Capital, we pointed out that the trial court had gone too far in declaring that any real estate loan was to be considered as a business loan for the purpose of the federal preemption. We wrote that a loan “for the purchase of a home by an individual may not be a ‘business’ loan. . . .” We agreed, however, that the loan was for business purposes because “Capital had every reason to believe that. . . [Briggs’s] payment of the Worsham note still related to a purchase of . . . [the development property].” We treated the issue as one of fact and held that the chancellor’s conclusion that it was a business loan was not clearly erroneous.

The main difference between the Briggs case and this one is that here the loan was made to allow Chateau Cantrell to purchase property which was already developed whereas in the Briggs case it was to conduct development. In their argument that the difference is essential, the appellees cite In re Lawson Square, Inc., 816 F.2d 1236 (8th Cir. 1987). First South, F.A., loaned Lawson Square, Inc., money to convert an apartment complex into condominiums for sale. A usury question arose, and the issue before the court of appeals was whether the Arkansas usury law (Amendment 60) was preempted by § 501 of the Depository Institutions Deregulation and Monetary Control Act of 1980.

First South argued that the loan to Lawson Square, Inc., was secured by a first lien on “residential property” and thus it was covered by the preemption found in § 501(a)(1)(A) of the act. The court of appeals agreed that the property in question was “residential.” The appellees here argue that if such property qualifies as residential under § 501 the loan may not qualify as one for business purposes under § 511. We know of no authority for that proposition and can see no logic in it. No explanation is given as to why the two preemptions do not or should not overlap.

The only other citation of consequence furnished by the appellees is to an opinion issued by the General Counsel of the Federal Home Loan Bank Board, March 19, 1981. The opinion was furnished to us as an appendix to the appellees’ brief, and the. Winns contest its legitimacy and move that it be stricken. We need not respond to the motion to strike, as we do not find the opinion to be controlling in this case whether or not it should be authoritative.

The opinion does not contain the facts upon which it is based. It states only that it is a response to an inquiry from a supervisory agent of the Federal Home Loan Board in Little Rock. It concludes that the “nature of the loan” for purposes of determining whether it is for business purposes is to be determined by the use to which the loan proceeds will be put and states:

The more difficult question is when does a loan have a business purpose. In construing the language in the National Bank Act, 12 U.S.C. § 85, which is virtually identical to that contained in § 511, the Office of the Comptroller of the Currency (OCC) takes the position that the loan proceeds must be used in the active conduct of a trade or business.. . . This construction would preclude the applicability of § 511 to loans for passive investments, i.e., business ventures in which the borrower will not take an active role in the operation or management of the enterprise.

Further on in the opinion, comments made by congressmen at the time the statute was enacted are discussed. Rep. St. Germain took the position that a loan by a broker to a margin investor would qualify as one for business purposes. The opinion states:

Since Rep. St. Germain’s position is inconsistent with traditional interpretations, we would advise the more cautious course and confine the business loan exemption to those loan transactions in which the proceeds will be used in active business investments.

While the opinion may or may not be authoritative, it does not necessarily cover the situation before us. It does not define “passive investment.” One investment perhaps thus described might be an investment in a stock or bond purchased on a public exchange. The average investor takes no active part in operation or management of AT&T. That is unlike the sort of investment we have here. The Chateau Cantrell partners could be said to be engaged in an “active business investment” albeit they are operating the apartment complex through Mr. Flake’s company as agent. The opinion, by saying that “active business investments” are included in loans for business purposes clearly does not exclude all loans for “investment” purposes, and thus we would not find it helpful even if we were to rule it acceptable as authoritative.

Conclusion

We agree with the Winns that our decision should be controlled by the Briggs case. We can see no significant distinction between the use to which the money was to be put by the borrowers here and the borrowers there. The Briggs case opinion recites nothing to the effect that Briggs and the others Capital was led to believe were engaged in a land development project intended to do the development personally. We have no quarrel with the facts found by the chancellor, but in a de novo review we are free to reach a different result required by the law. Ferguson v. Green, 266 Ark. 556, 587 S.W.2d 18 (1979); Larey, Comm’r v. Cont. Southern Lines, 243 Ark. 278, 419 S.W.2d 610 (1967). We do so here. Mr. Flake, the managing general partner, testified that he was in the business of buying, selling, and organizing the management of real estate properties. He derived part of his income from just such activities as this one. The fact that other partners motives were based on tax avoidance and “investment” does not, in our view, lessen the “business loan” nature of this transaction. Not only could the Winns have believed from the circumstances that Mr. Flake and his partners were buying the apartment complex for business purposes, that very declaration was made by the partnership in the note.

The case is remanded for the chancellor to sort out the entitlements to rents and profits as well as to rule on the question of attorneys’ fees.

Reversed and remanded.

Holt, C.J., not participating. Justice Glaze and Special Justice Judith A. DeSimone dissent.