Is the use of the 365/360 accrual method permissible in commercial loans? We have been made aware of an Illinois lawsuit challenging the use of this method (Kitson v. Bank of Edwardsville), but we always thought that if we disclosed our interest computation method, we had a safe harbor.

Yes, using the 365/360 accrual method is permissible for commercial loans in Illinois, provided that the loan documents clearly disclose and explain the method of calculation.

The court case you mention, Kitson v. Bank of Edwardsville, arose out of commercial promissory notes that stated an “annual” interest rate and then disclosed that this rate would be calculated using the 365/360 method. After an extensive consideration of procedural issues, the court held that the Interest Act requires an “annual” interest rate to be calculated on the basis of twelve calendar months comprised of 365 days. Consequently, the court determined that the bank’s use of the 365/360 method violated the “annual” interest rate term of the notes.

However, in response to Kitson, the Illinois General Assembly amended the Interest Act to clarify that annual interest rates in commercial loans may continue to be based on 360 days. Subsequent to this legislation, an Illinois court noted that Kitson appeared to be the only case that interpreted the Interest Act to prohibit the 365/360 method, and the court held that even before the General Assembly's repudiation of Kitson, the Interest Act clearly permitted banks to calculate interest on commercial loans using the 365/360 method.

It should be noted that the Credit Agreements Act still requires the “relevant terms and conditions” of a commercial loan to be set forth in the credit agreement, and this would include a clear explanation of the 365/360 interest rate calculation in the loan documents.

For additional information on this issue, including sample language for disclosing and explaining the 365/360 method in a commercial note, please read our 365/360 Interest Rate Legislation article on our compliance website: http://gotoiba.com/articles/365-360-interest-rate-legislation.

For resources related to our guidance, please see:

Illinois Interest Act, 815 ILCS 205/4(5) (“For purposes of items (a) and (c) of subsection (1) of this Section, a rate or amount of interest may be lawfully computed when applying the ratio of the annual interest rate over a year based on 360 days. The provisions of this amendatory Act of the 96th General Assembly are declarative of existing law.”)

Illinois Interest Act, 815 ILCS 205/4(1)(a) (“It is lawful to charge, contract for, and receive any rate or amount of interest or compensation with respect to the following transactions: (a) Any loan made to a corporation”)
First Bank of Beverly Hills v. River East Plaza. LLC, et al., No. 09 CH 8486, Circuit Court of Cook County, Chancery Division (January 26, 2010) (The court conducted an in-depth analysis of several provisions of the Interest Act prior to the recent amendment and determined the existing law clearly permitted interest to be calculated based on a 360-day year for commercial loans.)

Credit Agreements Act, 815 ILCS 160/2 (“A debtor may not maintain an action on or in any way related to a credit agreement unless the credit agreement is in writing, expresses an agreement or commitment to lend money or extend credit or delay or forbear repayment of money, sets forth the relevant terms and conditions, and is signed by the creditor and the debtor.”)