Can a lawyer help a client buy a dormant corporation so the client can borrow at an interest rate that would be usurious if lent to an individual?

Plain-English summary

An attorney (A) wished to buy property and build a professional building on it. Bank officials indicated he probably could not obtain a construction loan in his individual capacity but might be able to if he borrowed as a corporation, which could be charged a higher interest rate. He proposed to buy all the stock of a dormant corporation owned by other clients of his office (a corporation that had filed annual reports but conducted no business for some time), have it lease office space to himself and possibly others, and apply for the construction mortgage in the corporation's name, with title held by the corporation. The inquirer asked whether he could ethically participate.

The Committee framed the issue as factual rather than ethical. It restated the settled rule that an attorney who represents a borrower or lender in a usurious transaction participates in an illegal undertaking and is therefore guilty of unethical conduct (In re Giordano, citing the Committee's Opinion 71). But it also restated, from Opinion 118, that a lawyer may ethically participate in loans above the individual legal limit when the borrower is "a bona fide corporation, i.e., one not formed for the purpose of evading the Usury Statute." Reviewing the case law (Lesser v. Strubbe, where a corporate cloak was used to disguise an individual loan, and Gelber v. Kugel's Tavern, where usury was no defense to a genuine corporate loan), the Committee held that buying the stock of an existing corporation changes the form but not the substance of the transaction, and that an attorney cannot escape the duty to determine whether the transaction in substance involves usurious interest merely because of the form it takes.

Applying that test, the Committee found the facts "strikingly similar" to Monmouth Capital Corp. v. Holmdel Village Shops, Inc., where a developer incorporated to satisfy a lender's policy of lending only to corporations and the court found valid business reasons, no overreaching, and competent independent counsel, so the corporation was neither a shell nor a cloak and usury was no defense. Here, likewise, there was no evidence of overreaching, the client was independently protected by personal counsel, no other personal assets were pledged, and the security was the property to be acquired. The Committee indicated its opinion might be different were any of those factors absent.

Currency note

This opinion was issued in April 1970, before New Jersey's September 13, 1971 adoption of the Disciplinary Rules (Code of Professional Responsibility), so the Committee was applying the Canons of Professional Ethics and its own prior opinions. It also predates the 1984 Rules of Professional Conduct and all later revisions, as well as later amendments to New Jersey's usury law. A lawyer's duty not to assist a client in conduct the lawyer knows is criminal or fraudulent is now addressed under RPC 1.2(d). Treat this page as historical context, not current guidance. Verify against current rules and the current usury statute before relying on any specific rule or rate mentioned here.

Common questions

Q: Is it automatically unethical for a lawyer to help a client borrow through a corporation at above-usury rates?

A: No. The Committee held the question is factual. If the corporate borrower is bona fide (formed or used for valid business reasons, not solely to evade the usury statute), participation is ethical; only if the corporation is a sham cloak for an individual loan is it improper.

Q: Does buying an existing dormant corporation, rather than forming a new one, change the analysis?

A: Not by itself. The Committee said purchasing the stock of an existing corporation alters the form but not the substance, so the lawyer must still determine whether in substance the loan is to the corporation or to the individual.

Q: What facts made participation ethical here?

A: The Committee pointed to the absence of overreaching, the client's protection by independent personal counsel, the fact that no other personal assets were pledged, and that the loan was secured by the property being acquired, making the facts like Monmouth Capital Corp. It noted its opinion might differ if any of those factors were absent.

Background and rules framework

The opinion applied the principle that a lawyer may not participate in an illegal (usurious) transaction, drawn from the Committee's earlier Opinions 71 and 118 and from In re Giordano. The controlling distinction was between a genuine corporate borrower (usury no defense) and a corporation used as a cloak to disguise an individual loan. In current New Jersey terms, a lawyer's obligation not to counsel or assist a client in conduct the lawyer knows is criminal or fraudulent is governed by RPC 1.2(d).

Citations and references

Statutes:

• N.J.S.A. 31:1-1 et seq. (Usury Statute)

Cases:

• In re Giordano, 49 N.J. 210 (1967)
• In re Greenberg, 21 N.J. 213 (1956)
• Lesser v. Strubbe, 56 N.J. Super. 274 (Ch. Div. 1959)
• Gelber v. Kugel's Tavern, Inc., 10 N.J. 191 (1962)
• Monmouth Capital Corp. v. Holmdel Village Shops, Inc., 92 N.J. Super. 480 (Ch. Div. 1966)

Other opinions cited:

• NJ ACPE Opinion 71, 88 N.J.L.J. 170 (1965)
• NJ ACPE Opinion 118, 90 N.J.L.J. 749 (1967)

See also

• NJ ACPE Op. 289: Attorney Participation in a Usurious Loan
• NJ ACPE Op. 535: Confidentiality and a Fraudulent Insurance Claim

Source

• Full text (Justia mirror): https://law.justia.com/cases/new-jersey/advisory-committee-on-professional-ethics/2004/acp176-1.html
• Issuing authority: New Jersey Supreme Court Advisory Committee on Professional Ethics, via the NJ Courts Supreme Court Committees page

Original opinion text

Reproduced from a full-text mirror of the official opinion for research purposes. The linked official source controls.

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

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.