B-155904, JUN. 1, 1965, 44 COMP. GEN. 757

B-155904: Jun 1, 1965

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THE COMPOUNDING OF INTEREST MONTHLY ON THE UNPAID BALANCE ALTHOUGH PRODUCING AN EFFECTIVE ANNUAL RATE HIGHER THAN THE RATE OF INTEREST PROVIDED BY THE CONTRACT IS NOT ILLEGAL. A MONTHLY PAYMENT SCHEDULE FOR THE LIQUIDATION OF THE FINANCING INDEBTEDNESS INCURRED INCIDENT TO THE CONSTRUCTION OF THE BUILDING ALTHOUGH RESULTING IN A HIGHER EFFECTIVE ANNUAL INTEREST RATE LEGALLY IS NOT IN CONFLICT WITH THE LESSER RATE PROVIDED BY THE CONTRACT. ALTHOUGH RESULTING IN A HIGHER EFFECTIVE ANNUAL INTEREST RATE THAN THAT PROVIDED BY THE CONTRACT IS VALID. 1965: WE HAVE A LETTER DATED JANUARY 7. FROM THE CERTIFYING OFFICER OF YOUR BUREAU OF EMPLOYMENT SECURITY AS FOLLOWS: "THERE IS A QUESTION WITH REGARD TO THE PROPER AMOUNT OF A MONTHLY PAYMENT TO LIQUIDATE THE INDEBTEDNESS FOR THE CONSTRUCTION OF THE EMPLOYMENT SECURITY BUILDING AT SIXTH AND PENNSYLVANIA AVENUE.

B-155904, JUN. 1, 1965, 44 COMP. GEN. 757

INTEREST - COMPOUND - EFFECTIVE V. CONTRACT RATES. INTEREST - COMPOUND EFFECTIVE V. CONTRACT RATES UNDER A CONTRACT TO FINANCE THE CONSTRUCTION OF A PUBLIC BUILDING WHICH PROVIDES FOR THE AMORTIZATION OF THE LOAN IN EQUAL MONTHLY INSTALLMENTS OVER A 20-YEAR PERIOD, THE COMPOUNDING OF INTEREST MONTHLY ON THE UNPAID BALANCE ALTHOUGH PRODUCING AN EFFECTIVE ANNUAL RATE HIGHER THAN THE RATE OF INTEREST PROVIDED BY THE CONTRACT IS NOT ILLEGAL, THE COURTS HOLDING THAT THE FIXING OF A MAXIMUM RATE OF INTEREST "PER ANNUM" DOES NOT REFER TO THE TIME OR THE FREQUENCY OF THE PAYMENT OF INTEREST BUT TO THE RATE, AND AS A PUBLIC BODY AGREEING TO PAY INTEREST AT MONTHLY, QUARTERLY, OR SEMI-ANNUAL INTERVALS AT A STATED RATE PER ANNUM DOES NOT EXCEED ITS AUTHORITY TO PAY INTEREST AT NOT MORE THAN THAT RATE, A MONTHLY PAYMENT SCHEDULE FOR THE LIQUIDATION OF THE FINANCING INDEBTEDNESS INCURRED INCIDENT TO THE CONSTRUCTION OF THE BUILDING ALTHOUGH RESULTING IN A HIGHER EFFECTIVE ANNUAL INTEREST RATE LEGALLY IS NOT IN CONFLICT WITH THE LESSER RATE PROVIDED BY THE CONTRACT. IN VIEW OF THE GENERAL ACCEPTED FINANCIAL PRACTICE TO USE A NOMINAL ANNUAL RATE IN COMPUTING MONTHLY MORTGAGE PAYMENTS, A MONTHLY PAYMENT SCHEDULE PROPOSING TO AMORTIZE THE COST OF FINANCING THE CONSTRUCTION OF A PUBLIC BUILDING BY THE ACCEPTED STANDARD METHOD, ALTHOUGH RESULTING IN A HIGHER EFFECTIVE ANNUAL INTEREST RATE THAN THAT PROVIDED BY THE CONTRACT IS VALID, ABSENT A CONTRARY INTENT IN THE TERMS OF THE INVITATION, THE BID, OR THE CONTRACT.

TO THE SECRETARY OF LABOR, JUNE 1, 1965:

WE HAVE A LETTER DATED JANUARY 7, 1965, FROM THE CERTIFYING OFFICER OF YOUR BUREAU OF EMPLOYMENT SECURITY AS FOLLOWS:

"THERE IS A QUESTION WITH REGARD TO THE PROPER AMOUNT OF A MONTHLY PAYMENT TO LIQUIDATE THE INDEBTEDNESS FOR THE CONSTRUCTION OF THE EMPLOYMENT SECURITY BUILDING AT SIXTH AND PENNSYLVANIA AVENUE, NORTHWEST, WHICH I AM REQUIRED TO CERTIFY.

"THE BUILDING WAS AUTHORIZED AND CONSTRUCTED UNDER TITLE I OF THE DEPARTMENT OF LABOR, HEALTH, EDUCATION AND WELFARE ACTS OF 1959 (PUBLIC LAW 85-580); 1960 (PUBLIC LAW 86-158); 1961 (PUBLIC LAW 86 703); 1962 (PUBLIC LAW 87-290); 1963 (PUBLIC LAW 87-582); 1964 (PUBLIC LAW 88-136); AND 1965 (PUBLIC LAW 86-685). THE KANSAS CITY LIFE INSURANCE COMPANY WAS THE LOW BIDDER TO FINANCE THE CONSTRUCTION OF THE BUILDING. THE CONTRACT (COPY ENCLOSED) CALLS FOR INTEREST AT THE RATE OF 4.68750 PERCENT PER ANNUM.

"THE GENERAL SERVICES ADMINISTRATION ARRANGED FOR THE CONSTRUCTION AND FINANCING OF THE BUILDING AND BY WAY OF ADVICE PREPARED AND FURNISHED TO THE KANSAS CITY LIFE INSURANCE COMPANY AND THE BUREAU OF EMPLOYMENT SECURITY AN AMORTIZATION SCHEDULE (COPY ENCLOSED) WHICH RESULTED IN A LEVEL MONTHLY PAYMENT OF $28,338.88. THE METHOD OF COMPUTATION USED BY THE GENERAL SERVICES ADMINISTRATION IN PREPARING THE AMORTIZATION SCHEDULE IS SIMILAR TO THAT USED FOR OTHER FEDERAL BUILDINGS FINANCED BY THE KANSAS CITY LIFE INSURANCE COMPANY. THE KANSAS CITY LIFE INSURANCE COMPANY WISHES TO MAKE PAYMENTS IN ACCORDANCE WITH THAT SCHEDULE. HOWEVER, IN ANALYZING THE SCHEDULE THE BUREAU'S ACTUARY DISCOVERED THAT THE METHOD OF COMPUTATION RESULTED IN THE COMPOUNDING OF INTEREST MONTHLY AND PRODUCED AN ANNUAL EFFECTIVE INTEREST RATE OF 4.789530 PERCENT RATHER THAN THE CONTRACT RATE OF 4.68750 MONTHLY PAYMENT OF $28,104.65, A SAVINGS OF $234.23 MONTHLY, $2,810.76 ANNUALLY OR $56,215.60 OVER THE 20-YEAR AMORTIZATION PERIOD.

"THE KANSAS CITY LIFE INSURANCE COMPANY WAS FURNISHED A COPY OF THE BUREAU'S AMORTIZATION SCHEDULE BASED ON AN EFFECTIVE RATE OF INTEREST OF 4.68750 PERCENT PER ANNUM FOR ITS REVIEW AND CONCURRENCE. THE COMPANY WAS ALSO ADVISED THAT SINCE THE FIRST MONTHLY PAYMENT WAS DUE ON SEPTEMBER 21, 1964, WE WOULD MAKE PAYMENTS IN THE LOWER AMOUNT PENDING THE RESOLUTION OF THE ISSUE. THE KANSAS CITY LIFE INSURANCE COMPANY REFUSES TO ACCEPT THE BUREAU'S REPAYMENT COMPUTATION AND IS DEMANDING ADDITIONAL MONTHLY PAYMENTS OF $234.23 THE DIFFERENCE BETWEEN $28,338.88 AND $28,104.65.

"I WOULD LIKE YOUR ADVICE AS TO THE AMOUNT OF THE MONTHLY PAYMENT WHICH I SHOULD CERTIFY TO LIQUIDATE THE INDEBTEDNESS.'

THE FINANCING CONTRACT AWARDED BY THE GENERAL SERVICES ADMINISTRATION TO THE KANSAS CITY LIFE INSURANCE COMPANY (HEREAFTER REFERRED TO AS KANSAS CITY) PROVIDES THAT UPON COMPLETION OF THE CONSTRUCTION AGREES TO EXECUTE AND DELIVER TO THE INVESTOR A NOTE (IN THE FORM AND SUBSTANCE OF THE SPECIMEN COPY ATTACHED TO THE CONTRACT) PROVIDING FOR THE AMORTIZATION OVER A TWENTY-YEAR PERIOD OF THE AMOUNTS PAID OUT BY THE INVESTOR PLUS INTEREST TO THE COMPLETION DATE OF THE BUILDING. IN ACCORDANCE THEREWITH THE UNITED STATES,"ACTING BY AND THROUGH THE SECRETARY OF OR," EXECUTED AND DELIVERED A NOTE DATED AUGUST 21, 1964, BY WHICH IT PROMISED TO PAY TO THE ORDER OF KANSAS CITY THE SUM OF $4,408,558.52 "WITH INTEREST AT 4.68750 PERCENTUM PER ANNUM UNTIL PAID, PAYABLE IN EQUAL MONTHLY INSTALLMENTS IN ARREARS OVER THE TWENTY-YEAR TERM OF THIS NOTE, WITH THE FIRST INSTALLMENT HEREUNDER DUE AT THE END OF THE MONTH FOLLOWING THE DATE HEREOF.' THE QUOTED LANGUAGE, EXCEPT FOR THE RATE OF INTEREST INSERTED, WAS IDENTICAL WITH THE THE LANGUAGE OF THE SPECIMEN NOTE ATTACHED TO THE INVITATION FOR BIDS.

PRIOR TO THE ACTUAL DELIVERY OF THE NOTE, THE GENERAL SERVICES ADMINISTRATION FORWARDED TO KANSAS CITY FOR ITS APPROVAL THE FOLLOWING DOCUMENTS:

1. SCHEDULE OF PAYMENTS MADE AND COMPUTATION OF ACCRUED INTEREST DURING THE CONSTRUCTION PERIOD.

2. DRAFT OF THE NOTE TO BE DELIVERED.

3. SCHEDULE OF AMORTIZATION OF THE NOTE.

BY LETTER OF AUGUST 31, 1964, KANSAS CITY STATED ITS CONCURRENCE IN ALL THREE ITEMS.

THE SCHEDULE OF PAYMENTS THUS AGREED TO BETWEEN GSA AND KANSAS CITY WAS COMPUTED ON THE BASIS THAT EACH MONTHLY PAYMENT WOULD INCLUDE INTEREST ON THE UNPAID BALANCE AT ONE-TWELFTH OF THE ANNUAL RATE CONTRACTED FOR. THE CONTENTION OF YOUR DEPARTMENT IS THAT THIS METHOD OF COMPUTATION RESULTS IN THE COMPOUNDING OF INTEREST AND THE REALIZATION BY THE LENDER OF AN EFFECTIVE INTEREST RATE OF 4.78953 PERCENT, AND IS THEREFORE NOT IN ACCORDANCE WITH THE CONTRACT FOR INTEREST AT 4.6875 PERCENT.

IN SUBSTANCE, THIS POSITION RESTS UPON THE PROPOSITION THAT ONE DOLLAR RECEIVED EACH MONTH IS WORTH MORE TO THE RECIPIENT THAN TWELVE DOLLARS RECEIVED AT THE END OF THE YEAR, BECAUSE BY INVESTING THE MONTHLY PAYMENTS HE WILL HAVE A GREATER AMOUNT AT THE END OF THE YEAR. THIS IS NOT DISPUTED, BUT WE HAVE BEEN REFERRED TO NO JUDICIAL AUTHORITY SUPPORTING THE CONCLUSION THAT PAYMENT OF INTEREST AT MONTHLY INTERVALS AT ONE- TWELFTH OF A STIPULATED ANNUAL RATE IS LEGALLY IMPROPER UNDER AN AGREEMENT TO PAY AT THAT RATE. TWO LINES OF CASES INVOLVING SIMILAR QUESTIONS HAVE BEEN FOUND: ONE DEALING WITH THE POWER OF A MUNICIPALITY OR OTHER PUBLIC BODY, UNDER STATUTES AUTHORIZING A CERTAIN RATE OF INTEREST PER ANNUM, TO PROVIDE FOR THAT RATE TO BE PAID AT INTERVALS OF LESS THAN A YEAR; AND THE SECOND INVOLVING THE EFFECT OF USURY LAWS PROHIBITING THE CHARGING OF INTEREST IN EXCESS OF A STATED RATE PER ANNUM UPON CONTRACTS REQUIRING PAYMENT OF INTEREST AT THE MAXIMUM RATE AT INTERVALS OF LESS THAN A YEAR. IN BOTH SITUATIONS THE COURTS HAVE ALMOST UNANIMOUSLY HELD THAT STATUTES FIXING A MAXIMUM RATE OF INTEREST "PER ANNUM" DO NOT REFER TO THE TIME OR FREQUENCY OF PAYMENT OF INTEREST BUT MERELY TO THE RATE. ON THIS BASIS, THEREFORE, IT IS THE GENERAL RULE THAT AN AGREEMENT BY A PUBLIC BODY TO PAY INTEREST QUARTERLY OR SEMI-ANNUALLY AT A STATED RATE PER ANNUM IS NOT IN EXCESS OF ITS AUTHORITY TO PAY INTEREST AT NOT MORE THAN THAT RATE. SIMILARLY, A CONTRACT REQUIRING PAYMENT OF INTEREST AT MONTHLY, QUARTERLY, OR SEMI-ANNUAL INTERVALS AT THE MAXIMUM RATE ALLOWED BY STATUTE DOES NOT VIOLATE THE STATUTORY PROHIBITION AGAINST CHARGING INTEREST IN EXCESS OF THAT RATE PER ANNUM. CASES OF BOTH CLASSES ARE CITED IN AN ANNOTATION AT 29 A.L.R. 1109. SEE ALSO 22 COMP. GEN. 656.

IN VIEW OF THE FOREGOING, WE ARE UNABLE TO CONCLUDE THAT THE MONTHLY PAYMENT SCHEDULE PREPARED BY GSA IS LEGALLY IN CONFLICT WITH THE CONTRACTUAL AGREEMENT FOR PAYMENT OF INTEREST AT THE RATE OF 4.6875 PERCENT.

THERE REMAINS ONLY THE QUESTION WHETHER THE SCHEDULE IS IN ACCORD WITH THE INTENT OF THE PARTIES AS EXPRESSED IN THE INVITATION, BID, AND ACCEPTANCE WHICH GIVE RISE TO THE CONTRACT.

THE GENERAL SERVICES ADMINISTRATION REPORTS ITS ACTION IN THE MATTER AS FOLLOWS:

"PRIOR TO THE EXECUTION OF THE CONTRACT, REPRESENTATIVES OF THIS AGENCY HAD DISCUSSED WITH ACTUARIES OF THE TREASURY DEPARTMENT THE METHOD OF AMORTIZING THE TYPE OF INDEBTEDNESS INVOLVED IN THIS TRANSACTION. THE METHOD OF AMORTIZATION REFLECTED BY OUR SCHEDULE CONFORMS TO THE INFORMATION RECEIVED DURING THE CONSULTATIONS WITH THE TREASURY DEPARTMENT ACTUARIES.

"TO DETERMINE THE MONTHLY LEVEL OF PAYMENT AND ITS APPLICATION TO INTEREST ACCRUED AND REDUCTION OF PRINCIPAL, GSA FOLLOWED THE GENERALLY ACCEPTED COMMERCIAL PRACTICE OF DIRECT REDUCTION WHICH CALLS FOR AN EQUAL PAYMENT EACH MONTH OVER A DEFINITE PERIOD OF YEARS. IN DETERMINING THE INTEREST PAYABLE AT THE END OF MONTHLY INTERVALS, WE APPLIED THE PRINCIPAL SET FORTH IN 22 COMP. GEN. 656-658. GSA COMPUTED INTEREST AT THE CONTRACT RATE ON THE UNPAID PRINCIPAL BALANCE OF THE NOTE AND APPLIED ONE-TWELFTH OF THE ANNUAL INTEREST AS ACCRUED FOR THE CURRENT MONTH WITH THE RESIDUE BEING APPLIED AS REDUCTION OF PRINCIPAL.'

IN CONNECTION WITH THE FINAL SETTLEMENT AND ISSUANCE OF THE NOTE, GSA FORWARDED TO KANSAS CITY A DRAFT OF THE NOTE AND THE SCHEDULE OF AMORTIZATION OF THE NOTE FOR THAT COMPANY'S REVIEW AND CONCURRENCE OR EXCEPTION. KANSAS CITY CONCURRED IN THE NOTE AND ACCOMPANYING SCHEDULE AS PREPARED BY GSA.

THE RECORD SHOWS THAT AFTER THE CONTROVERSY AROSE AND AT THE REQUEST OF KANSAS CITY, THE FINANCIAL PUBLISHING COMPANY OF BOSTON, MASSACHUSETTS, PREPARED A MONTHLY PAYMENT SCHEDULE, BASED ON THE PROVISIONS OF THE NOTE, WHICH AGREES, WITHIN ONE CENT, WITH THE GSA PAYMENT COMPUTATION. KANSAS CITY ALSO STATES THAT THE FINANCIAL VICE PRESIDENT OF BANKERS LIFE INSURANCE COMPANY, DES MOINES, IOWA, THE ONLY OTHER BIDDER ON FINANCING THE BUILDING PROJECT, HAS ADVISED THAT ITS INTEREST RATE BID ON 4.87 PERCENT WAS BASED ON THE SAME UNDERSTANDING AS KANSAS CITY AS TO THE GENERALLY ACCEPTED FINANCIAL PRACTICES FOR COMPUTING REPAYMENT OF SUCH INSTALLMENT NOTES. IT IS ALSO NOTED THAT NEITHER THE CERTIFYING OFFICER NOR GSA HAS QUESTIONED KANSAS CITY'S FURTHER STATEMENT THAT THE FORM OF THE SUBJECT INVITATION TO BIDDERS IS IDENTICAL TO THAT USED BY GSA IN THE FINANCING OF OTHER PROJECTS FOR WHICH THAT AGENCY USED THE SAME METHOD IN COMPUTING THE AMORTIZATION SCHEDULES.

IN VIEW OF THE CONFLICTING METHODS EMPLOYED BY YOUR BUREAU OF EMPLOYMENT SECURITY AND GSA FOR COMPUTING THE PAYMENTS, THE VIEWS OF THE TREASURY DEPARTMENT WERE REQUESTED ON WHETHER THE METHOD ADOPTED BY GSA FOR COMPUTING THE MONTHLY INSTALLMENTS WAS PROPER UNDER THE CIRCUMSTANCES HERE INVOLVED. TREASURY'S VIEWS IN THE MATTER ARE STATED IN PERTINENT PART AS FOLLOWS:

"THERE IS LITTLE DOUBT THAT THE BASIS EMPLOYED BY GENERAL SERVICES FOR THE COMPUTATION OF MONTHLY PAYMENTS IN THIS CASE IS THE STANDARD METHOD FOLLOWED IN THIS COUNTRY. TO THE BEST OF OUR KNOWLEDGE NO AGENCY IN THE GOVERNMENT NOR ANY FINANCIAL INSTITUTION OUTSIDE THE GOVERNMENT ORDINARILY INVOLVED WITH MORTGAGES CURRENTLY USES ANYTHING OTHER THAN THE NOMINAL ANNUAL RATE IN COMPUTING MONTHLY MORTGAGE PAYMENTS. THE OVERWHELMING MAJORITY OF MORTGAGES INVOLVING THE FEDERAL GOVERNMENT ARE FHA AND VA MORTGAGES. WITHOUT EXCEPTION THE INTEREST PAYMENTS ON THESE ARE COMPUTED ON A NOMINAL RATE BASIS. (AN EXPLANATION OF THE DIFFERENCE BETWEEN A NOMINAL AND AN EFFECTIVE RATE IS CONTAINED IN THE KANSAS CITY LIFE INSURANCE COMPANY LETTER DATED DECEMBER 29, 1964. IT IS ALSO NOTED, TO AVOID POSSIBLE CONFUSION, THAT THE "GOVERNMENT ACTUARY" REFERRED TO IN THAT LETTER IS THE LABOR DEPARTMENT ACTUARY.)

"IN A MORTGAGE NOTE, THE LANGUAGE PERTAINING TO THE ANNUAL INTEREST RATE IS NOT CUSTOMARILY EXPLICIT AS TO WHETHER THE RATE IS A NOMINAL OR AN EFFECTIVE RATE. IN MOST FHA CONTRACTS, THE USE OF THE RATE IS IMPLIED BY THE STATEMENT OF THE AMOUNT OF THE LEVEL MONTHLY PAYMENT IN THE BODY OF THE CONTRACT AS WELL AS BY A SUPPORTING SCHEDULE OF AMORTIZATION PAYMENTS. IN OTHER FHA CONTRACTS, WHERE THERE IS NOTHING MORE THAN THE USUAL STATEMENT OF THE INTEREST RATE IN THE BODY OF THE NOTE, THE INTERPRETATION OF THE RATE IS AGAIN IMPLIED BY A SUPPORTING SCHEDULE. EITHER CASE THE SCHEDULE OF PAYMENTS CAN BE REPRODUCED BY INTERPRETING THE ANNUAL RATE OF INTEREST IN ONLY ONE WAY, AS A NOMINAL RATE.'

IN VIEW OF THE FOREGOING, IT APPEARS THAT THE PAYMENT SCHEDULE PREPARED BY GSA WAS IN ACCORD WITH THE PRACTICE OF FINANCIAL INSTITUTIONS IN THIS COUNTRY, AND WITH THE PRACTICE OF THE GOVERNMENT, AT LEAST IN FEDERAL HOUSING ADMINISTRATION AND VETERANS ADMINISTRATION INSURED MORTGAGES.

IN VIEW THEREOF, AND SINCE NOTHING IN THE TERMS OF THE INVITATION OR THE BID OR THE CONTRACT INDICATED ANY CONTRARY INTENT, WE PERCEIVE NO ADEQUATE BASIS FOR QUESTIONING THE VALIDITY OF THE PAYMENT SCHEDULE AGREED TO, OR FOR MAKING MONTHLY PAYMENTS TO KANSAS CITY IN AN AMOUNT LESS THAN THE $28,338.88 COMPUTED BY GSA, AND VOUCHERS FOR SUCH PAYMENTS MAY BE CERTIFIED FOR THAT AMOUNT. HOWEVER, WE ARE SUGGESTING TO THE ADMINISTRATOR OF GENERAL SERVICES ADMINISTRATION THAT CONSIDERATION BE GIVEN TO THE INCLUSION IN FUTURE FINANCING CONTRACTS OF A MORE PRECISE STATEMENT OF THE METHOD TO BE USED IN COMPUTING THE PAYMENTS PROVIDED FOR, SO AS TO AVOID ANY POSSIBILITY OF QUESTION THEREOF.