Daily Archives: February 24, 2011

Calculating Interest on Commercial Loans: Recent Legislation Expressly Permits Illinois Lenders to Use the “365/360″ Method

Lenders throughout Illinois can breathe a sigh of relief now that Governor Pat Quinn has signed Public Act 96-1421, which amends the Illinois Interest Act to expressly permit use of the “365/360″ method of calculating interest on commercial loans.

Leading up to this development, a flurry of class action lawsuits against financial institutions have called into question the legality of the well-established interest computation method, which has been routinely used by commercial lenders “since time immemorial,” according to one Cook County Circuit Court judge. Plaintiffs throughout the state have asserted that commercial promissory notes violate Illinois usury law when they specify that interest will be calculated according to a 360-day year and the actual number of days elapsed (i.e., 365). This claim is rooted in the Illinois Interest Act, which stipulates that interest must be calculated based on a year comprised of 12 calendar months (i.e., 365 days) whenever a promissory note specifies a “per annum” or “per year” interest rate—as virtually all commercial promissory notes do. Plaintiffs have also claimed that using the “365/360″ method constitutes common law fraud and violates the Illinois Consumer Fraud Act. Making matters worse for lenders, defendants in mortgage foreclosure cases—lacking any other way to extricate themselves from failing business deals and save their properties—have raised the illegality of the interest calculation method as an affirmative defense.

The economic underpinning of the borrowers’ claims is that use of the “365/360″ method results in a higher effective interest rate than the rate stated on the note. For example, if a promissory note establishes the interest rate at 5% per annum, with interest calculated according to a 360-day year and the actual number of days elapsed, then the effective interest rate will be 5.069444%, or 5% x (365/360). That means a borrower will pay an extra $694.44 a year in interest on a $1 million note. While trial court judges in Cook County have sided with the lenders in recent decisions, one downstate class action case resulted in a substantial settlement in favor of the plaintiffs.

Understandably, this rash of litigation put fear in the hearts of commercial lenders throughout Illinois and galvanized the industry to lobby for legislation. The result was Public Act 96-1421, which became law in August 2010 and amended the Illinois Interest Act to provide that “a rate of interest may be lawfully computed when applying the ratio of the annual interest rate over a year based on 360 days.” The act further states that the provisions of the amendment “are declarative of existing law.” Interestingly, however, the sponsor of the bill in the Illinois state senate remarked for the record that the “legislation will not dictate the outcome of any pending [litigation]. That will be up to the individual courts to apply the law.”

While it may be back to business as usual—at least with respect to calculating interest for commercial loans—lenders should take careful note that Public Act 96-1421 only applies to commercial loans and is silent with respect to consumer and residential mortgage loans. Lenders should also consider certain precautions to minimize the risk of future litigation. In addition to clearly setting forth in the loan documents that interest will be calculated on a “365/360″ basis, lenders should require borrowers to acknowledge that use of this method will result in an effective interest rate that is higher than the stated interest rate.

Aspartame Class Action Dismissal Affirmed on Statute of Limitations Grounds

On January 28, 2011, the Third Circuit Court of Appeals in an unpublished opinion affirmed the 2008 decision of the District Court for the Eastern District of Pennsylvania to toss the Aspartame class action on statute of limitations grounds. The court of appeals agreed that the plaintiffs could not invoke the equitable doctrine of fraudulent concealment to toll the four-year statute of limitations for antitrust claims. In re Aspartame Antitrust Litig., Case No. 09-1487. Doc # 003110422286, filed 1/28/2011 (hereafter “Op.”).

The class plaintiffs asserted claims under Section 1 of the Sherman Act, 15 U.S.C. § 1, alleging that the defendants had conspired to fix the prices of and allocate the market for Aspartame, an artificial sweetener, since at least January 1, 1993. Op. at 2; see also In re Aspartame Antitrust Litig., No. 2:06-CV-1732-LDD, 2008 WL 4724094, at *1 (E.D. Pa. Aug. 11, 2008). The underlying class action was commenced in April, 2006, making the applicable statute of limitations, April 2002.

Neither of the two named plaintiffs – Nog, Inc. or Sorbee International, Ltd. – purchased any Aspartame product after 2001, with Nog’s last purchase occurring in 1995 and Sorbee’s in 2001. The district court initially had denied a motion to dismiss on statute of limitations grounds, finding that, although plaintiffs’ factual allegations relating to fraudulent concealment were “not robust,” the issue should be decided “on a developed factual record” and allowed the case to proceed to discovery. Op. at 2 (internal quotation marks omitted).

Discovery revealed, however, that neither plaintiff took any steps to investigate its claims. Nog’s president and Rule 30(b)(6) designee testified that Nog purchased roughly $454 worth of Aspartame from Defendant NutraSweet in 1994 and 1995. He further testified that, while Nog believed that “the price [of Aspartame] was out of sight” when it began purchasing the product, no one at Nog complained to NutraSweet, attempted to negotiate a price reduction, or investigated the existence of other suppliers because Nog believed that NutraSweet was the only Aspartame supplier. Op. at 3; see also Aspartame Antitrust Litig., 2008 WL 4724094, at *5 (Nog’s designee testified to belief that NutraSweet “was the only game in town”).

Sorbee’s vice president and Rule 30(b)(6) designee testified that the company purchased roughly $47,500 worth of Aspartame between 1997 and 2001 and similarly denied having undertaken any investigation of the Aspartame market. He disclaimed any knowledge as to whether the company had negotiated the price of the Aspartame it purchased or attempted to obtain Aspartame at a lower price from any other supplier. He was also unable to answer “the most basic questions concerning the Aspartame market; he admitted that he had no understanding of the balance of supply and demand, the fluctuation in the price of raw materials, or the prevailing price tendered by other direct purchasers.” Op. at 3-4; see also Aspartame Antitrust Litig., 2008 WL 4724094, at *5 (noting Sorbee’s designee had “no recollection about the ‘negotiation, price paid, bidding, or process of purchasing Aspartame’”).

Under these facts – and given that the named plaintiffs’ purchases were all outside the limitations period – the district court granted the defendants’ later summary judgment motion, finding that the “complete lack of any diligence by the Plaintiffs precludes them from invoking the equitable doctrine of fraudulent concealment.” Aspartame Antitrust Litig., 2008 WL 4724094, at *6. The district court pointed to “storm warnings” that as a whole put the plaintiffs on inquiry notice and triggered a duty to investigate. Id. at *6. These warnings included (1) plaintiffs’ belief that the price of Aspartame was “out of sight” and that NutraSweet was the sole supplier in the market, (2) the filing of several anti-competition suits in other jurisdictions naming some of the defendants, and (3) a 1993 Harvard study about the conditions of the Aspartame market, all of which “collectively revealed significant barriers to entry and lack of competition in the Aspartame market.” Aspartame Antitrust Litig., 2008 WL 4724094, at *6; Op. at 6-7.

The court of appeals affirmed, holding that, under the foregoing facts, “[e]ven if we assume that defendants fraudulently concealed their anticompetitive conduct, there is simply no evidence to show that plaintiffs exercised the level of due care necessary to toll the limitations period.” Id. at 6. The court also rejected plaintiffs’ argument that “their complete inactivity [was] justified by the sophistication of defendants’ concealment” and that “until there is some outward indication of a price-fixing conspiracy, plaintiffs cannot be expected to do anything at all.” Id.Pointing to the “storm warnings” noted by the district court, the court of appeals found this argument unpersuasive and held, “Although these warnings were not particularly ominous, they certainly required plaintiffs to do something. . . . Instead, both parties sat on their hands. Equity will not excuse such unjustified inactivity.” Id. at 7 (emphasis in original; internal citations omitted)