Carboni v. Arrospide

• Decision Date: 27 December 1991
• Docket Number: No. A050612,A050612
• Citation: 2 Cal.App.4th 76,2 Cal.Rptr.2d 845
• Court: California Court of Appeals Court of Appeals
• Parties: , 16 UCC Rep.Serv.2d 584 Michael J. CARBONI, Plaintiff and Appellant, v. Jorge ARROSPIDE, Sr., Defendant and Respondent.

Page 845

2 Cal.Rptr.2d 845

2 Cal.App.4th 76, 16 UCC Rep.Serv.2d 584

Michael J. CARBONI, Plaintiff and Appellant, v. Jorge ARROSPIDE, Sr., Defendant and Respondent.

No. A050612.

Court of Appeal, First District, Division 3, California.

Dec. 27, 1991.

Rehearing Denied Jan. 21, 1992.

Review Denied March 19, 1992.

David M. McKim, Carr, McClellan, Ingersoll, Thompson & Horn, Burlingame, for plaintiff and appellant.

No appearance for defendant and respondent.

WHITE, Presiding Justice.

In this case we consider whether a secured note providing for interest at a rate of 200 percent per annum is unconscionable. In the circumstances presented here, we conclude that it is.

I FACTS

The evidence at trial established that on July 27, 1988, George Arrospide, Jr., signed a $4,000 note and deed of trust on behalf of his father, Jorge Arrospide, Sr., as his attorney in fact. The note was made in favor of Michael Carboni, a licensed real estate broker. It carried an interest rate of 200 percent per annum, was due in three months, and was secured by a fourth deed of trust on a residence owned by Jorge Sr. located at 36 Alexander in Daly City. The loan documents indicate the security had a value of $250,000 with existing encumbrances of $193,000.

The parties originally intended the note would be paid off in a single lump sum payment of $6,000 after three months. However, over the next four months, Carboni continued to make cash advances to Jorge Sr. which were secured by the original note and deed of trust. By November 25, 1988, the principal amount of the note had ballooned to $99,346, all of which was carried at an interest rate of 200 percent per annum. At the time of trial in March of 1990, the principal and accumulated interest amounted to nearly $390,000.

The testimony was sharply divided concerning the purpose for the loan. Carboni testified that the money was advanced directly to George Jr. to be used to refurbish residential property which he intended to resell at a profit. The Arrospides, on the other hand, claimed the money was used for Jorge Sr.'s "personal obligations"--primarily to pay medical expenses for his ailing parents who lived in Peru. George Jr. testified that his father was under "emotional duress" because of these personal obligations, and that he obtained the loan at his father's specific instruction.

The Arrospides also claimed the parties agreed not to secure the note, or, at least, not to record the deed of trust which George Jr. had executed. The purported reason for this condition was that there was a pending sale on the residence at 36 Alexander, and the Arrospides did not want to jeopardize the sale by having another deed of trust "pop up" on the property. Nevertheless, Carboni recorded the deed of trust the same week it was executed.

When Jorge Sr. failed to make any payments on the note after demand, Carboni filed his complaint for judicial foreclosure and deficiency judgment on June 21, 1989. Jorge Sr. appeared at the court trial in pro per. Following testimony from both sides, the trial court issued the following memorandum decision: "While in regard to short term loans of ninety days or so, as was anticipated here, interest at the rate of 200% per annum may or may not shock the conscience of the Court, interest at that rate for one and one-half years does. Accordingly, the Court finds that enforcement of the interest rate provisions of the notes herein involved for the time period involved is against public policy. The Court will allow interest on the principal sum at the rate of 24% per annum, to date."

The trial court entered judgment permitting interest at the rate of 24 percent per annum and foreclosing the property. After the trial court denied a motion to vacate the judgment, Carboni appealed. ¹

II DISCUSSION ²

A. The Law of Unconscionability.

The present case is controlled by CIVIL CODE SECTION 1670.5³, ⁴ which provides: "(a) If the court as a matter of law finds the contract or any clause of the contract to have been unconscionable at the time it was made the court may refuse to enforce the contract, or it may enforce the remainder of the contract without the unconscionable clause, or it may so limit the application of any unconscionable clause as to avoid any unconscionable result." In making this determination, the court should consider the commercial setting, purpose, and effect of the contract. (§ 1670.5, subd. (b).)

Section 1670.5 was enacted in 1979. (Stats.1979, ch. 819, § 3.) Before that time, however, California courts long recognized "unconscionability" as a viable common law doctrine even in the absence of specific statutory authority. (A & M Produce Co. v. FMC Corp. (1982) 135 Cal.App.3d 473, 484, 186 Cal.Rptr. 114 (A & M Produce ); Perdue v. Crocker National Bank (1985) 38 Cal.3d 913, 925, 216 Cal.Rptr. 345, 702 P.2d 503.) Moreover, section 1670.5 was adopted verbatim from section 2-302 of the Uniform Commercial Code; however, section 1670.5 expanded its coverage to include all contracts. (A & M Produce, supra, 135 Cal.App.3d at pp. 484-485, 186 Cal.Rptr. 114; Perdue v. Crocker National Bank, supra, 38 Cal.3d at p. 925, fn. 10, 216 Cal.Rptr. 345, 702 P.2d 503.) Thus, in interpreting section 1670.5, we may look to cases analyzing section 2-302 of the Uniform Commercial Code and to the common law.

Surprisingly, the parties have not cited, and we have not discovered, any case which applies the doctrine of unconscionability to specifically annul or reform a loan which bears a shockingly high rate of interest. ⁵ Although one respected commentator has suggested this would be a proper application of the unconscionability doctrine, ⁶ it appears it has rarely, if ever, been applied in this context. Nevertheless, we believe we may look to cases finding unconscionability on the basis of gross price disparity as analogous authority. In essence, the interest rate is the "price" of the money lent; at some point the price becomes so extreme that it is unconscionable. ⁷

Although it is a simple matter to say that at some point an interest rate becomes unconscionable, it is more difficult to determine when that point is reached. Professor Williston has explained that unconscionability "... is an amorphous concept obviously designed to establish a broad business ethic.... [p] The concept of unconscionability was meant to counteract two generic forms of abuses, the coincidence of both forms being necessary to a finding of the concept's applicability. [p] The first type of abuse relates to procedural deficiencies in the contract formation process, taking the form either of deception or a refusal to bargain over contract terms. [p] The second type of abuse involves the substantive contract terms themselves and may be analyzed according to four specific sub-categories of abuses including: ... 4. [p] Unexpectedly harsh terms manifested in the form of price disparity." (15 Williston on Contracts (3d ed. 1972) § 1763A, pp. 213-215, fn. omitted, quoted in Truta v. Avis Rent A Car System, Inc. (1987) 193 Cal.App.3d 802, 819, 238 Cal.Rptr. 806.)

The leading California case on unconscionability generally follows Professor Williston's analysis of the issue. In A & M Produce, supra, 135 Cal.App.3d 473, 186 Cal.Rptr. 114 the court recognized that unconscionability has both a "procedural" and a "substantive" aspect. (Id., at p. 486, 186 Cal.Rptr. 114.) The procedural aspect is manifested by (1) "oppression," which refers to an inequality of bargaining power resulting in no meaningful choice for the weaker party, or (2) "surprise," which occurs when the supposedly agreed-upon terms are hidden in a prolix document. (Ibid.)

"Substantive" unconscionability, on the other hand, refers to an overly harsh allocation of risks or costs which is not justified by the circumstances under which the contract was made. (A & M Produce, supra, 135 Cal.App.3d at p. 487, 186 Cal.Rptr 114.) Presumably, both procedural and substantive unconscionability must be present before a contract or clause will be held unenforceable. However, there is a sliding scale relationship between the two concepts: the greater the degree of substantive unconscionability, the less the degree of procedural unconscionability that is required to annul the contract or clause. (Ibid.; West v. Henderson (1991) 227 Cal.App.3d 1578, 1587-1589, 278 Cal.Rptr. 570; Dean Witter Reynolds, Inc. v. Superior Court (1989) 211 Cal.App.3d 758, 768, 259 Cal.Rptr. 789.) ⁸

B. Analysis.

With these general principles in mind, we must now determine whether the trial court correctly concluded that the interest rate provision was unconscionable. Although unconscionability is ultimately a question of law, numerous factual inquiries bear upon that question. "To the extent there are conflicts in the evidence or in the factual inferences which may be drawn therefrom, we must assume a set of facts consistent with the court's finding of unconscionability if such an assumption is supported by substantial evidence." (A & M Produce, supra, 135 Cal.App.3d at p. 489, 186 Cal.Rptr. 114.)

1) Substantive Unconscionability.

We have little trouble concluding that an interest rate of 200 percent on a secured $99,000 loan is substantively unconscionable; i.e., that it imposes a cost on the borrower which is overly harsh and was not justified by the circumstances in which the contract was made. (Dean Witter Reynolds, Inc. v. Superior Court, supra, 211 Cal.App.3d at p. 768, 259 Cal.Rptr. 789.) However, "deciding the issue is substantially easier than explaining it." (Jones v. Star Credit Corp. (1969) 59 Misc.2d 189, 298 N.Y.S.2d 264, 266.)

We note first that according to Carboni's own testimony, the interest rate (200 percent) was approximately ten times the rate then prevailing in the credit market for similar loans. ⁹ Thus, the "price" of the credit was, by at least one objective measure, roughly ten times its value. ¹⁰ Courts have found sales contracts...