Texas Court of Appeals Invalidates Home Equity Interpretive Regulations

In a decision granting little deference for the regulations issued by the Finance Commission of Texas and the Credit Union Commission of Texas (collectively, the "Commissions"), the Texas Court of Appeals in Austin, Texas eschewed the definition of "interest" under the Texas Finance Code (the "Code") for a definition which effectively rewrites the regulations. In its ruling, the court has declared the Commissions' regulations concerning the fee caps for home equity loans unconstitutional, and therefore it is presently unclear which fees are subject to the cap. Until the Commissions adopt new regulations, lenders should consider all fees charged in connection with home equity loans – other than the stated interest rate on the loan and the possible exception of discount points – to be potentially subject to a three percent cap. A copy of the decision is attached.

Background. In 1997, Texas amended its Constitution to become the last state in the Union to permit loans to homeowners secured by the  quity in their residences. In 2003, the Texas Constitution was amended again to authorize the legislature to delegate the authority to issue interpretations of the Texas Constitution's home equity lending provisions to a state agency. The Texas Legislature delegated this authority to the Commissions.

Under the Texas Constitution, fees charged in connection with a home equity loan may not exceed three percent of the principal amount of the loan. "Interest," however, is exempt from the cap. In defining "interest" for purposes of the fee cap exception, the Commissions' interpretative regulations adopted a well-established definition of "interest" found in the Code's usury provisions "and as interpreted by the courts." The Code's usury provisions define "interest" as "compensation for the use, detention and forbearance of money." Based on this definition, Texas courts had for years concluded that unless the lender was providing a good or service other than the making of the loan, all fees to the lender were "interest" for purposes of the state's usury laws.

ACORN's Lawsuit. The Association of Community Organizations for Reform Now ("ACORN") brought suit challenging the Commissions' definition of "interest." While purporting to grant deference to the Commissions' interpretation, the Court of Appeals declared the Commissions' definition of "interest" unconstitutional in the context of the home equity fee cap, holding that the definition was contrary to the plain language of the Texas Constitution. In particular, the Austin court noted that the definition of interest under the usury statutes was designed to have a broad interpretation in order to provide the maximum protection of the usury laws to consumers, but that utilizing that same broad definition for purposes of the fee cap exception defeated the consumer protection objective of the three percent cap.

The Court stressed that it was merely invalidating the Commissions' regulations, and that the Commissions were "free to adopt another  definition of interest that is consistent with the plain language of the constitution." However, the Court's interpretation of that "plain language" makes clear that it would regard any definition of interest that encompassed any fees – with the possible exception of discount points – to be contrary to the plain language and thus unconstitutional. Unless and until the Commissions adopt new regulations, lenders should, as a safe harbor, consider virtually any fee charged in connection with a home equity loan to be subject to the three percent cap.

Expect an appeal of this decision to the Texas Supreme Court. We will monitor the progress of any appeal of this decision and report to you as events unfold. 

If you have any questions regarding this Consumer Financial Services Alert or the fee cap provisions for home equity loans in Texas, you may contact Richard Gottlieb, leader of the Consumer Financial Services practice, at 312-627-2196, or Tom Hanson 214-462-6420.

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