Usury - Purchase of Inactive Corporation to Obtain Mortgage

93 N.J.L.J. 252
April 9, 1970

ADVISORY COMMITTEE ON PROFESSIONAL ETHICS
 
Appointed by the New Jersey Supreme Court
 

OPINION 176

Usury - Purchase of Inactive
Corporation to Obtain Mortgage

An attorney (A) inquires whether he may ethically participate

in the transaction herein described.

A desires to purchase property upon which is located an abandoned residence. He plans to erect a professional building on the premises. He proposes to execute a contract with a mortgage contingency clause and to apply to a bank for financing in the form of a construction loan. He spoke with bank officials and ascertained that he probably could not get the loan if he applied in his individual capacity but somehow he discovered that possibly he could obtain such a loan if he were incorporated and could therefore be charged a higher interest rate.
 
Other clients of the inquirer's office had formed a corporation some years ago, the stock of which is held by three individuals. The corporation has reported each year to the Secretary of State, but has not actively been used for any business purposes for some time. It is proposed that A purchase all of the stock of the corporation, either alone or together with members of his immediate family. He proposes to have the corporation execute a conditional lease from itself as landlord to himself individually as tenant for office space. Possibly leases also will be executed with other prospective tenants. He then proposes that the corporation will apply for a construction mortgage showing the above lease or leases as evidence of prospective income to the bank. The mortgage would be applied for in the name of the corporation, and title to the property would be held in the name of the corporation, and the construction mortgage to the bank also would be in the name of the corporation.
 
The purchase price for the stock of the corporation will be approximately the cost of forming the corporation, plus the annual fees paid by the corporation to the Secretary of State. The corporation has been in existence for more than two years.
 
The specific method for A obtaining corporate status has been suggested by the attorney. He is willing to sign a statement after full explanation that he understands that he could not be charged an interest rate greater than 8% per annum if he applied in his individual capacity for the mortgage loan; that he believes that his chances are better for getting a loan if he applies in corporate form; that neither the inquirer's office nor anyone else has told him that he must apply in corporate form for the mortgage and that he understands that he does not have a presently existing corporation to apply for the loan that he wished to obtain.
 
If the transaction is in fact usurious, there is no question but that the attorney may not participate. Our Supreme Court has stated that an attorney who represents a borrower or a lender in a usurious transaction is participating in an illegal undertaking, and is therefore guilty of unethical conduct. In re Giordano, 49 N.J. 210 (1967), in which our Opinion 71, 88 N.J.L.J. 170 (1965), is cited with approval.
In our Opinion 118, 90 N.J.L.J. 749 (1967), we noted that an attorney could ethically participate in loans at a rate of interest in excess of the legal limit when the borrower "is a bona fide corporation, i.e., one not formed for the purpose of evading the Usury Statute (N.J.S.A. 31:1-1 et seq.)."
The fact that the borrower proposes to purchase the stock of an existing corporation alters the form, but not the substance, of the transaction. In Lesser v. Strubbe, 56 N.J. Super. 274, (Ch. Div. 1959), it was held that a loan represented by a corporate note and secured by a corporate mortgage and individual guarantees was in fact a loan to individuals and not to the corporation where the facts showed that a prospective purchaser of property was induced
to buy the stock of the corporation and dummy minutes of meetings were written to bring about the individual's election as an officer of the existing corporation at a time when the stock certificates had not been delivered to him. A $600,000 loan was then negotiated involving a premium charge of $70,000 and interest at 6% for one year with an increase of 2% a month thereafter. The court said: The evidence impels the conclusion that this transaction was a mortgage loan to Strubbe, individually, but that in order to avoid the defense of usury the corporate cloak was used. Id. at 285.
 
The question for decision is not ethical, but factual. The question is whether the proposed loan is actually to be made in substance to the corporation or to the individual. If loans are actually made to a corporation, usury is not a defense even to the endorsers of the corporate obligation, Gelber v. Kugel's Tavern, Inc., 10 N.J. 191, 196 (1962), and an attorney can ethically represent individual guarantors of corporate loans at rates in excess of the legal rate. Opinion 71, 88 N.J.L.J. 170 (1966). But an attorney "cannot escape the responsibility of determining whether the particular transaction involves the payment of interest in excess of the permitted maximum merely because of the form the loan transaction takes." Opinion 71, supra.
Thus, in Monmouth Capital Corp. v. Holmdel Village Shops, Inc., 92 N.J. Super. 480 (Ch. Div. 1966), where an individual land developer incorporated to comply with the lender's policy of "only (making) loans to corporations," the court found that the loan was based upon "valid business reasons." Since there was no evidence of overreaching and since the borrower was at all times represented by competent counsel the court found the borrower corporation not to be either a shell or a cloak and usury not a defense. The court noted that a contrary holding would mean that in every situation in which a corporation is formed in what is known as a "start up" venture, a lender loaning money at more than the legal rate of interest would be subjecting itself to a later claim of usury.
The facts of the subject inquiry are strikingly similar to the Monmouth Capital Corp. case. There is no evidence of overreaching. The client is being individually protected by personal counsel and no other personal assets of the borrower are being pledged to guarantee the loan. Moreover, the security for the loan is the property to be acquired by the loan.
Were any of these factors absent, our opinion might be different for an attorney "cannot escape the responsibility of determining whether the particular transaction involves the payment of interest in excess of the permitted maximum merely because of the form the loan transaction takes." See Opinion 71, 88 N.J.L.J. 170 (1965), citing In re Greenberg, 21 N.J. 213 (1956), which was a disciplinary proceeding involving formation of a corporation for the sole purpose of receiving a loan which if made to an individual would be usurious.

In In re Greenberg the attorney represented the conflicting interests of both borrowers and lender and failed to advise the borrowers that with the collateral which they already had they could have obtained a direct loan or that they should seek independent advice.
Our courts had not always held that incorporation to obtain a loan was illegal In Corradini v. V. & M Holding Corp., 34 N.J. Super. 427 (Ch. Div. 1955), the court relying upon Jenkins v. Moyse, 254 N.Y. 319, 172 N.E. 521, 74 A.L.R. 205 (Ct. App. 1930), held that the loan was not made to the corporation for the purpose
of evading the statute, but in order to comply with it. But since In re Greenberg, supra, the use of the corporate device to evade the usury statute has been sharply condemned:
In Gelber v. Kugel's Tavern, Inc., supra, this court recently served notice that use of the corporate shell to cloak a loan which was actually being made to an individual borrower would in nowise be permitted to defeat the usury laws of our State. In re Greenberg, 21 N.J. 213, 220 (1956).
 
The facts of the subject inquiry, however, disclose a loan which is being made in substance to a new corporate venture which will acquire with the new venture capital the asset to be pledged to secure the loan. That being so, we feel that the loan is being made to the corporation and not to the individual and the attorney may participate. Cf. Opinion 118, supra.
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