Request By:
Mr. John L. Williams, Jr.
Commissioner
Department of Banking and Securities
911 Leawood Drive
Frankfort, Kentucky 40601
Opinion
Opinion By: Steven L. Beshear, Attorney General; Elizabeth E. Blackford, Assistant Attorney General
You have written to ask the opinion of this office concerning the following questions:
1. At what rate may a bank renew a note which involves an original principal amount of $15,000 or less and has a six month maturity date where the discount rate has increased in the interim between the making of the original note and the date of execution of the renewal note.
Answer: KRS 287.214 permits state banks to charge interest "at any rate allowed national banking associations by the laws of the United States of America." 12 USCA § 85 sets the maximum interest rate at 1% in excess of the excess of the discount rate in effect at the time the loan or note is made.
While 12 USCA § 85 determines the amount of the maximum permissible interest rate, it sheds no insight upon whether interim increases in the permissible interest rate may be reflected as an increased interest charge upon renewal. For that we must turn to the Truth in Lending Act, 12 USCA1601 etseq., and the interpretations thereof rendered by the Board of Governors of the Federal Reserve.
The Board of Governors has held, via interpretations of the Truth in Lending Act, that renewal notes may not charge interest at a rate higher than that charged in the original obligation. 12 CFR 226.811; 12 CFR § 226.903; 12 CFR 226.8(j). In order to utilize any interim increases in the permissible interest rate, the new note must be treated as a refinancing, a new transaction, and must be accompanied by the appropriate disclosures. 12 CFR 226.811; 12 CFR 226.903; 12 CFR 8(j).
Thus, national banking associations are not permitted to incorporate any increases in the permissible interest rate as an increased interest charge upon renewal. Rather, the maximum permissible interest rate allowed national banking associations upon renewals is that rate which was disclosed in the original obligation.
State banks are, of course, subject to the proscriptions of the Truth in Lending Act. 12 USCA § 1601, etseq. Thus, they too would be subject to the limitation that interest charges in excess of those disclosed in the original obligation, though not usurious by reason of interim rises in the discount rate, may not be implemented in a renewal note. The interim increases may be implemented only through the vehicle of refinancing, a new transaction.
Thus, the short answer to your question is that the bank may renew a note only at a rate which is the same as or lower than the rate disclosed in the original note regardless of an interim increase in the discount rate, though it is free to refinance the obligation at an increased rate of interest which reflects the interim increase in the discount rate.
2. At what rate may the bank renew a note involving a principal sum of $15,000 or less which bears a six month maturity date where the discount rate has decreased in the interim between the time the original note was made and the time the renewal note is made?
Answer: A renewal constitutes the re-establishment of the original obligation for a new period of time. It carries forward the terms and provisions of the original note, the only change being that the borrower is granted an extension of time in which to perform the original obligation. 11 Am.Jur.2d, Bills and Notes § 307. Pursuant to this rationale, the Idaho courts have held that where a note was renewed at the same rate of interest as was charged in the original note, the defense of usury was not available against the renewal note even though the maximum permissible interest rate had been lowered by statute between the time the original note was executed and the time the renewal note was made because it was obvious that the new note was merely a renewal of the original obligation and not an effort to avoid the lower interim interest rates. Dufresne v. Hammersten, 106 P.2d 861, 61 Idaho 714 (1940).
Whether the rationale of Dufresne would be applicable in the context of renewals on loans made under KRS 287.214 is less than clear. The statutory scheme involved in Dufresne maintained a constant maximum permissible interest rate for long periods of time. The original note in that case had been outstanding for two years prior to the renewal. The interest charge on the original obligation had remained the same for that period of time. Thus, when the note was renewed at the same rate of interest as was charged on the original obligation, the presumption that the renewal was merely a continuation of the original obligation, as opposed to an effort to avoid the decrease in the maximum permissible interest rate wrought by interim statutory change, was strong. Under KRS 287.214, the statutory scheme envisions changes in the permissible interest rates every few months. The obligations which are to be renewed will have been outstanding for only a few months. Thus, the factors which created the presumption of Dufresne are not present on renewals of loans made pursuant to KRS 287.214. Furthermore, it may well be that in saying that a bank may charge the maximum rate permitted under 12 USCA, § 85, on "money due or to become due" on any contract or other written obligation, the legislature intended that the rate to be charged upon renewal should be determined at the time of renewal.
In summary, there is insufficient data upon which to base an opinion as to whether or not interim decreases in the permissible interest rate shall be reflected in a commensurately lower charge of interest upon renewal. 1
3. If the note is made which involves an original principal amount greater than $15,000, but the principal is reduced through payment to $15,000 or less by the time of renewal, at what rate may the note be renewed?
Answer: Both KRS 360.010 and KRS 287.214 contain the language "where the original principal amount is $15,000 or less" as the threshold amount for contracts and obligations to which the interest rates established therein apply. This office has previously opined, with reference to KRS 360.010, that this language means that it is the original amount of the loan which governs whether contract rates or statutory rates apply and that reductions in principal amount to $15,000 or less will not bring a loan which was not originally subject to KRS 360.010 under that statute. OAG 74-803; OAG 73-738, copies enclosed.
The legislature used the same language in KRS 287.214. Pursuant to the rationale espoused in these opinions, it is the opinion of this office that the legislature did not intend that the interest rate set by KRS 287.214 should be applicable to renewals of notes which involved an original principal amount greater than $15,000 even though the amount owed has been reduced to $15,000 or less at the time of the renewal.
Where the new note is in fact a renewal, and not a refinancing, it is not a new transaction, but merely a continuation of the original obligation. 11 Am.Jur.2d, Bills and Notes § 307. The original principal amount is not the amount remaining owing at the time of the renewal, but rather, the amount owed under original obligation. Consequently, KRS 287.214 will not be applicable though the amount still outstanding is $15,000 or less. The bank may charge interest upon renewal at the original contract rate.
4. Would the answer to the foregoing questions be different if the note is a demand note?
A demand note is, by definition, a note which is payable upon sight or presentation or which contains no specific date upon which payment is due. KRS 355.3-108. The problem of renewal would arise only where the note has been called or presented, or, in the instance of a demand note which bears an alternative fixed maturity date, where the note reaches the stated maturity date. In each instance, the note has matured. Cf. Board of Governor Ruling: Eligibility of demand paper for discount and as security for advances by reserve banks. 12 CFR 201.108. Once matured, the legal devices for extending the time for performance of the obligation are refinancing and renewal. The "demand" characteristics of the note have no impact after maturity. Consequently, the answers to the foregoing questions do not differ with regard to the renewal of a matured demand note.
There is, however, a special practice available in demand notes which deserves mention. Rather than agreeing to a fixed rate of interest, the bank and the borrower may agree, and may set out as a term in the note, to a rate of interest which will vary over the course of the life of the note. This variable interest charge will be tied to or predicated upon some scale such as, for instance, the discount rate plus one percentum standard of 12 USCA, § 85. In this instance, if the appropriate disclosures are made pursuant to 12 CFR § 226.8(b)(8), the annual percentage rate charged on the demand note may be increased, so long as the increase is within the limitations and conditions which have been disclosed, without causing the demand note to mature. See 12 CFR 226.815; disclosure for demand loans. The change in rates will not act as a demand or call of the note, and will not be a refinancing. 12 CFR 226.8(b)(8)(iv); Cf. 12 CFR 226.707.
In this instance, the note will continue ad infinitum despite any and all interim increases in the interest charge, so long as such increases are within the disclosed limitations. The increases do not cause the note to mature. However, if the increase is beyond that permitted by the limitations set out in the terms of the note and disclosed pursuant to 12 CFR § 226.8(b)(8) it will cause the note to mature and the transaction shall be considered a refinancing.
In summary, with this exception, the fact that the note is a demand note has no impact upon the answers to the foregoing question. The demand note would be treated like any other in those circumstances.
Footnotes
Footnotes
1 The provisions of the Truth in Lending Act are not helpful in making this determination. Pursuant to a ruling of the Board of Governors, where the interest charged on renewal is the same as, or lower than, the interest charged on the original obligation, the transaction is considered a continuation of the original obligation, rather than an independent transaction, such that no new disclosures are required by the Act. 12 CFR 226.817. However, this does not answer the question of whether the bank is required to renew at a lower rate.