Mencor Enterprises, Inc., v. Hets Equities Corp.

• Decision Date: 19 March 1987
• Court: California Court of Appeals Court of Appeals
• Parties: MENCOR ENTERPRISES, INC., etc. et al., Plaintiffs and Appellants, v. HETS EQUITIES CORPORATION et al., Defendants and Respondents. D004050.

Page 464

235 Cal.Rptr. 464

190 Cal.App.3d 432

MENCOR ENTERPRISES, INC., etc. et al., Plaintiffs and Appellants, v. HETS EQUITIES CORPORATION et al., Defendants and Respondents.

D004050.

Court of Appeal, Fourth District, Division 1, California.

March 19, 1987.

Neil G. Strachan, San Diego, for plaintiffs and appellants.

Styn & Garland, Ronald L. Styn and Tawn H. Skousen, San Diego, for defendants and respondents.

BUTLER, Associate Justice.

This appeal concerns applicability as a matter of law of the choice of law by parties to a contract. A California borrower sued its Colorado lender for treble the amount of interest paid on a promissory note, claiming the 44 percent rate was usurious. The note provided for application of Colorado law which permits an interest rate not to exceed 45 percent. The court sustained the lender's demurrer to the complaint for usury without leave to amend, holding as a matter of law the Colorado 44 percent rate selected by the parties did not constitute usury entitling the California borrower to sue for damages under California usury law. We shall conclude the applicability of Colorado law in the circumstances presented involves factual determinations, and reverse.

I

The demurrer admits the well-pleaded allegations of the complaint. We recite those allegations as our factual statement.

Mencor Enterprises, Inc., a California corporation, signed as maker a promissory note for and received $140,000. Hets Equities Corporation, a Colorado corporation, was the lender. The note called for 44 percent interest, ¹ principal and interest payable in Colorado or at any address as designated by the holder of the note. Principal and interest were payable in monthly installments of $2,500 commencing October 1, 1982. Unpaid interest and principal were payable August 1, 1984. The note included the following:

"This is a Colorado Note executed and funded in the State of Colorado to Holder, a Colorado corporation. As to all matters concerning this Note, suit may be brought in a Colorado court and the laws of the State of Colorado shall apply."

The note permitted Mencor to execute supplemental promissory notes the beginning of each quarter covering unpaid interest for the preceding quarter. These notes likewise have a 44 percent interest rate and were payable with the principal note August 1, 1984. Mencor signed and delivered four supplemental notes, one for each of the four quarters following execution of the principal note, all of which showed Denver, Colorado in the upper right hand corner. The first two supplemental notes included this paragraph:

"This is a Colorado Note executed and funded in the State of Colorado to Holder, a Colorado corporation. As to all matters concerning this Note, suit may be brought in a Colorado court and the laws of the State of Colorado shall apply."

The last two supplemental notes had this paragraph:

"This is a Colorado Note supplementing Maker's Note of August 27, 1982 which earlier Note was executed and funded in the State of Colorado to Holder, a Colorado corporation. As to all matters concerning this Note, suit may be brought in a Coloardo [sic] court and the laws of the State of Colorado shall apply."

Mencor ² made eight monthly payments of $2,500, skipped three months, made a principal payment of $50,194.11, skipped another month, and then made three more payments of $1,700, $1,692.35 and $1,692.35, the last on February 1, 1984. After a demurrer was sustained to Mencor's first complaint for usury filed June 21, 1984, Mencor filed a first amended complaint for usury. The demurrer to that complaint was sustained without leave to amend. Mencor appeals the judgment dismissing the complaint and awarding attorney fees to Hets.

II

The parties to a contract may specify the law to be followed in matters concerning the contract and a California court will apply the law so selected if enforcement of the contract does not result in an evasion of settled public policy or California law protective of the rights of its citizens. (Frame v. Merrill Lynch, Pierce, Fenner & Smith, Inc. (1971) 20 Cal.App.3d 668, 673, 97 Cal.Rptr. 811.) Frame concerned a controversy between a brokerage firm and a former employee as to forfeiture of profit-sharing benefits under a plan which provided the rights of the parties would be governed by New York law. The forfeiture was valid under that law. The court declined to follow New York law.

"We recognize that the choice-of-law question is not foreclosed by the existence of an applicable California statute where New York State has substantial contacts with the transaction and the parties, if no attempt to evade California law appears. But an agreement designating applicable law will not be given effect if it would violate a strong California public policy. [Citations.] Here Business and Professions Code section 16600 explicitly declares that 'every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void.' The California Supreme Court in Muggill v. Reuben H. Donnelley Corp. [1965] 62 Cal.2d 239, at page 242 [42 Cal.Rptr. 107, 398 P.2d 147], has on closely similar facts held a forfeiture provision to be invalid. We conclude from the California Supreme Court's treatment of the problem that section 16600 does represent a 'strong public policy' of this state. Therefore, the agreement for application of New York law must not be allowed to defeat that policy." (Frame, supra, at p. 673, 97 Cal.Rptr. 811.)

We considered validity of a choice-of-law provision and claim of usury in Gamer v. DuPont Glore Forgan, Inc. (1976) 65 Cal.App.3d 280, 135 Cal.Rptr. 230. A customer of a brokerage firm claimed interest rates charged on margin accounts were usurious under California law. The margin account agreement made New York law applicable. That law permitted an interest rate higher than California's rate. The trial court followed the New York law and granted the broker's motion for summary judgment. We affirmed and referred to rules in Restatement Second of Conflict of Laws ³ to support our conclusion California's policy against usury was not offended and New York law was applicable.

The analysis of conflicts law in 1 Witkin, Summary of California Law (8th ed. 1973) Contracts, §§ 55-87, pp. 64-92, follows that of the Second Restatement for a number of reasons, including "California usually follows the Restatement in every substantive field." (Witkin, supra, at p. 67.) Here, the trial court concluded Gamer was controlling as a matter of law. We disagree. In Gamer, the choice-of-law issue was determined on a motion for summary judgment. The trial court made findings of fact based on declarations and we employed those factual findings in our analysis and conclusions. As Gamer is distinguishable, we turn to Restatement rules as the beginning of analysis of the issue presented here. Section 203 addresses usury and choice of law:

"The validity of a contract will be sustained against the charge of usury if it provides for a rate of interest that is permissible in a state to which the contract has a substantial relationship and is not greatly in excess of the rate permitted by the general usury law of the state of the otherwise applicable law under the rule of § 188." (At p. 649.)

Two determinations must be made under section 203. First, the relationship of the state of chosen law to the contract, second, the difference between the rates of interest of the forum and the chosen law state.

We pass for the moment those issues. Section 203 by its reference to section 188, Law Governing in Absence of Effective Choice by the Parties, ⁴ applies to determination of governing law concerning usury as to contracts where the parties have not made an effective choice of law.

Comments to the section support the view section 203 is applicable where the parties have not agreed upon a choice of law and a court is required to determine applicable law. The rationale of section 203 is:

"A prime objective of both choice of law (see § 6) and of contract law is to protect the justified expectations of the parties. Subject only to rare exceptions, the parties will expect on entering a contract that the provisions of the contract will be binding upon them. For this reason, the courts will not apply an invalidating rule to strike down the contract unless the value of protecting the justified expectations of the parties is outweighed in the particular case by the interest of the state with the invalidating rule in having this rule applied. Usury is a field where this policy of validation is particularly apparent." (At p. 650.)

Other comments bear on the phrase "substantial relationship" if a contract refers to two or more states. Thus, a state must have a normal and rational relationship to the contract and the parties. "The required relationship is unlikely to be based solely upon contacts purposely located in the state by the parties in an attempt to gain the benefit of that state's usury statute" (com. c to § 203, at p. 651). The determination of substantial relationship includes consideration of the domicile state of the borrower, the state where the loan is to be repaid provided that state bears a normal and natural relationship to the contract, the state where the loan was made or negotiated and the place of business of the lender (id. at pp. 651-652). Comment e to section 203 notes:

"Choice of law by the parties. A choice of law by the parties will not secure application of a law that would not otherwise be applicable to sustain a contract against the charge of usury. This is primarily because of the liberality of the present rule. Under it, the forum will examine the general usury statutes of all states which have a substantial relationship to the contract and apply the statute which either sustains the contract in full or else imposes the lightest penalty for usury. The parties will not be...