When is a Loan Unconscionable?
by Roger T. Manwaring

A borrower, perhaps faced with foreclosure, may argue that the loan should be rescinded because it was unconscionable when made. While unconscionability can justify rescission of a loan, the borrower will likely find it difficult to establish. Courts, find that a loan is unconscionable only in the most extreme circumstances.

A loan contract is unconscionable if “it [is] such as no man in his senses and not under delusion would make on the one hand, and as no honest and fair man would accept on the other” or “when the sum total of its provisions drives too hard a bargain for a court of conscience to assist.” In re: Sullivan, 346 B.R. 4, 24 (Bkrtcy. D. Mass. 2006), quoting In re: Maxwell, 281 B.R. 101, 127 (Bkrtcy. D. Mass. 2002), quoting Waters v. Min Ltd., 412 Mass. 64 (1992). 

In order to prove unconscionability, the plaintiff must, show both substantive unconscionability (that the terms are oppressive to one party) and procedural unconscionability (that the circumstances surrounding the formation of the contract show that the aggrieved party had no meaningful choice and was subject to unfair surprise).  

Sullivan, 346 B.R. at 25, quoting Storie v. Household Intern., Inc., 2005 WL 3728718, at *9 (D. Mass. Sept. 22, 2005).  “Procedural unconscionability evaluates the circumstances under which the contract was executed to determine if it is the product of unfair surprise. Substantive unconscionability evaluates the actual terms of the contract to determine if they are substantively unfair.” Sullivan, 346 B.R. at 25. “The test is a conjunctive one; that is, a plaintiff must prove both substantive and procedural unconscionability to prevail on this theory.” Id. at 26.

Gross disparity of values exchanged.
An important factor in determining is whether there was a “gross disparity of values exchanged” such that the “plaintiff gained no advantage.” Sullivan, 346 B.R. at 24, quoting Maxwell, 281 B.R. at 127. “Courts may avoid enforcement of a bargain that is shown to be unconscionable by reason of “gross inadequacy of consideration accompanied by other relevant factors.” Id. However, no such gross disparity exists where the debtor derives at least some benefit from the loan. In Sullivan, for example, the court held that two loans were not substantively unconscionable where they successively lowered the interest rate payable by the borrower and the income reported by the borrower indicated that she could have afforded to make the monthly payments. Further, the borrower obtained some cash from each loan. 346 B.R. at 30.

Borrower sophistication.
Another important factor is the sophistication of the borrower. Where the debtor is an educated professional, read the loan documents, had experience reviewing HUD Settlement Statements, understood the significance of APR and the difference between variable and fixed rate loans, knew of his or her right to rescind, and was not unfairly surprised by the loan terms, a court will not find that the loan was unconscionable. Sullivan, 346 B.R. at 29-30.

Predatory loan terms and the failure to provide disclosures.
In ruling that the loans before it were not unconscionable, the Sullivan Court distinguished the far more egregious facts of Maxwell, where the loan was held to be unconscionable. In Maxwell, the borrower was an 83 year old woman with minimal schooling and limited financial resources. She was induced to enter into two loan transactions which ultimately involved a negatively amortizing loan and a balloon payment. Further, the loan payments constituted 98.5% of the total monthly income of the borrower and her co-obligor. While the first loan had a 15 year term, the second had only a five year term and a 16% APR. The borrower also alleged that she had not been given TILA disclosures, nor had she been informed of the balloon payment. Maxwell, 281 B.R. at 106-07.

Who initiated the transaction.
Arguably, a loan is more likely to be unconscionable it as in Maxwell, the lender of a loan broker finds the borrower and convinces the borrower to take a loan, than if a borrower seeking a loan initiates the transaction.

Procedural unconscionability.
In addition to the factors outlined above, which relate to substantive unconscionability, the court must determine whether the facts support a finding of procedural unconscionability. This analysis focuses on unfair surprise. If it can be shown that the borrower was aware of the basic terms of the loan well before closing a claim of procedural unconscionability will likely fail.

Is your case more like Sullivan or Maxwell.
Naturally, counsel representing a lender will argue that the case being tried is more like Sullivan than Maxwell, and counsel for the borrower will take the opposite position. Counsel should compare the value received by the borrower, the borrower’s sophistication, the loan terms, the presence or absence of required disclosures, and the facts surrounding he initial contact, to the circumstances in Sullivan and Maxwell.

If you have questions regarding this or any other legal matter, please contact Roger T. Manwaring at rtm@barronstad.com or (617) 531-6584.