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Unaffordable Contracts Held Unendforceable

The Court of Appeal for San Jose has held that borrowers could sue the lender and the buyer at a foreclosure sale to have the loan held to be unenforceable, where the loan required payments $1000.00 per month higher than the borrowers' monthly income. That the contract costs more than a party can afford, is a new legal defense. It could be applied to automobile loans and leases, real estate and home purchase contracts, landlord-tenant rents, and even the high interest rates and fees on payday loans and credit cards. We read in the media, complaints by tenants advocates about rent increases which raise the rent to amounts the tenants cannot afford, as a defense and opposition to market rate rents. Here is a judicial decision supporting that as a legal defense.

This case will be a binding precedent, unless Bank of America or the new owner of the property appeals to the California Supreme Court. Until there is a superseding judicial decision, parties to a contract need to know whether or not the other side can afford to complete the contract.

The defense to enforcement of a contract that the contract is unconscionable, requires proof of two forms of unconscionability, procedural unconscionability and substantive unconscionability. The more procedurally unfair the making of the contract was, the less substantively unfair the contract needs to be in order to deny it enforcement. The more substantively unfair the contract is, the less procedurally unfair the negotiation and formation of the contract needs to be.

In this case, the Court of Appeal the lawsuit alleged a low degree of procedural unconscionability. The loan documents and disclosures were standard pre-printed forms and included all the statutory and customarily required disclosures and warnings. The Court of Appeal found that the threshold minimum of procedural unfairness was raised by the allegations that the plaintiffs have limited English fluency and education, and that the loan documents were on standard pre-printed forms which could not be negotiated or changed. There was no allegation of surprise or that the plaintiffs did not know that the monthly payments would be greater than their monthly income.

Even though the Court of Appeal stated that the complaint alleged a low degree of procedural unconscionability, at trial it could be found that the disparity between the monthly loan payments and the borrowers' income was so extreme that it made the contract unfair substantively that the contract could be held unenforceable.

If the case goes to trial, I don't know what the plaintiffs' remedy will be. The property was sold at a foreclosure sale, and the plaintiffs were evicted through a standard unlawful detainer eviction lawsuit and judgment. The plaintiffs do not claim that they had the financial ability to payoff the loan. The loan was for $525,000.00. Assuming the loan amount was 80% of the value at the time the loan was made, their damages might be that 20% equity of $105,000.00, plus attorney fees pursuant to the contract. A lot of Countrywide loans at the time used inflated or faked appraisals. The actual value at the time the loan was made and the borrowers' equity might have been less, zero, or even negative, in which case they might have suffered little or no damages, respectively.

If you have questions about negotiating and drafting a contract so that it is not vulnerable to a claim that it is unconscionable and therefore unenforceable, please call me.

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