ARKANSAS SUPREME COURT DEFINES USURY RATE On October 12, 2006, the Arkansas Supreme Court defined the Arkansas usury rate as five percent above the “Federal Primary Rate.” This ruling resolved an issue created by the Federal Reserve Board on January 9, 2003 when it abolished the “Federal Discount Rate” and created the “Federal Primary Rate.” The Arkansas Constitution provides that the maximum rate of interest charged on any contract shall not exceed five percent above the Federal Discount Rate. When the Federal Reserve Board eliminated its Federal Discount Rate, it became impossible for Arkansas lender’s to calculate the usury rate with certainty. In late 2002, the Arkansas Attorney General opined that if the Federal Reserve Board eliminated the Federal Discount Rate, that the Arkansas Supreme Court would most likely select the new Federal Primary Rate as the appropriate reference for calculating the usury limit. Most finance lawyers and nonbank lenders chose to follow the Attorney General’s opinion knowing that such opinions are not binding on the courts. In the meantime, various trade associations representing non-bank consumer creditors lobbied in Washington for Federal legislation preempting the application of Arkansas’ usury law. Federal and statechartered banks had effectively preempted Arkansas’ usury law through prior Federal legislation. At this time, non-bank lenders have not succeeded in preempting the remaining effectiveness of Arkansas’ usury law. During this period of judicial and constitutional uncertainty, an Arkansas woman sold a house to another Arkansas woman and agreed to finance the sale herself. Apparently unaware of the legal uncertainties created by the Federal Reserve Board’s action and the Attorney General’s opinion, the seller charged an interest rate of eight percent. Apparently she chose that rate because banks in her community charged similar rates. At the time she entered into the installment sales contract with the purchaser, the Federal Primary Rate was two percent. Under the logic of the Attorney General’s opinion, the Arkansas usury rate should have been seven percent and the loan was usurious. After making thirty payments on the installment sales contract, the purchaser sued the seller alleging usury. The trial court granted the seller’s motion for summary judgment and determined as a matter of law that with the abolition of the Federal Discount Rate, the Arkansas usury rate was also abolished. The trial judge reasoned that the people of Arkansas adopted a specific Federal reference rate and that when the Federal Reserve Board abolished that rate it adopted not only the Federal Primary Rate, but also 2 other rates (the Secondary Rate and the Seasonal Rate). The trial judge further reasoned that if the people chose a specific rate and that rate no longer existed, he did not have the power to substitute another rate. The purchaser appealed to the Arkansas Supreme Court by reiterating the arguments of the Attorney General: that the people of Arkansas intended to create a maximum interest rate and that despite the impossibility of calculating that rate based on the Constitutional formula approved by the people, the Court should liberally construe the Constitution to effectuate the people’s intent. The Arkansas Supreme Court reasoned that the Primary Rate was similar to the old Discount Rate (although it was substantially higher) and ordered that it be used to calculate the usury rate in Arkansas. The Court then remanded the case back to the trial court to apply the new rule to determine whether the rate of interest charged by the seller was in fact usurious. Although the possibility still exists that further appeals in the case just decided, or new Federal legislation, will again change Arkansas’ usury law, the Arkansas Supreme Court has, for the time being,
removed any uncertainty. Since January 9, 2003, the usury rate formula has been the Federal Primary Rate on the date of the contract plus five percent. THESE MATERIALS HAVE BEEN PREPARED BY MR. GOODWIN FOR INFORMATIONAL PURPOSES ONLY AND ARE NOT LEGAL ADVICE. THIS INFORMATION IS NOT INTENDED TO CREATE, AND RECEIPT OF IT DOES NOT CONSTITUTE, A LAWYER-CLIENT RELATIONSHIP. READERS SHOULD NOT ACT UPON THIS INFORMATION WITHOUT SEEKING PROFESSIONAL COUNSEL. Mr. Goodwin is a shareholder of Gill Elrod Ragon Owen & Sherman, P.A. located at 425 West Capitol Ave., Suite 3801 in Little Rock, Arkansas 72201. The firm can be found online at www.gill-law.com. Mr. Goodwin welcomes your comments and questions and can be reached by telephone at (501) 376-3800, by facsimile at (501) 372-3359 and by e-mail at Goodwin@gill-law.com. Gill Elrod Ragon Owen & Sherman, P.A. is a full service business law firm. Mr. Goodwin’s practice focuses on corporate and municipal finance, asset acquisition and divestitures, real estate development, securities, general corporate and contract law.