New York Court Finds Sale of Future Receivables is Not Subject to Usury Laws

A small business funder entered into an agreement with a business to purchase a portion of the business’ future receivables for an upfront lump sum. In exchange for the lump sum payment, the funder was to receive 9% of the business’ daily proceeds until the funder received the total amount of purchased receivables.

Within ten days of receiving the purchase price, the business refused to allow any of its receivable proceeds to be forwarded to the funder. As a result, the funder filed a complaint against the business and obtained a default judgment. The business later filed a motion to vacate the judgment. The business argued that the transaction was not a true purchase and sale but rather a usurious loan.

After reviewing the business’ arguments the trial court denied the motion. First, the court held that the business, which was a corporation, was barred from asserting civil usury because that defense is unavailable to corporate entities in New York. Second, the court found that business’ had failed to sufficiently allege a criminal usury defense because it failed to allege that the funder had knowingly charged, took or received annual interest in excess of 25% on a loan or forbearance.

The court explained that usury laws are only applicable to loans and forbearances and that where a financial arrangement is a purchase and sale there can be no usury. The court specifically found that the agreement between the parties was a purchase of future receivables for an upfront payment and highlighted aspects of the transaction that it found conclusively proved that there was no loan:

The repayment was based upon a percentage of daily receipts, and the period over which such payment would take place was indeterminate. Plaintiff took the risk that there could be no daily receipts, and defendants took the risk that, if receipts were substantially greater than anticipated, repayment of the obligation could occur over an abbreviated period, with the sum over and above the amount advanced being more than 25%. The request for the Court to convert the Agreement  to a loan, with interest in excess of 25%, would require unwarranted speculation, and would contradict the explicit terms of the sale of future receivables in accordance with the Merchant Agreement.

As a result, the court found that the business’ defense of usury was entirely without merit and denied the motion to vacate.

Merchant Cash & Capital, LLC v G&E Asian Am. Enter., Inc., 2016 N.Y. Misc. LEXIS 3067, 2016 NY Slip Op 31592(U)

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Excessive Interest Caused By Contingency Under Debtor’s Control Not Usurious

A horse owner provided a loan to a horse trainer. The promissory note required simple interest payments of 4% per annum. The trainer had the option of providing free training for two of the owner’s horses in lieu of paying interest. When the note came due 10 years later, the trainer failed to repay the principal. The owner then filed suit for breach of contract and moved for summary judgment.

The trainer offered two defenses. First, it argued that the value of the free training services provided to the owner should be deducted from the amount due on the note. The court, however, rejected this argument. The court held that nothing in the note stated that the value of the training provided would be used to reduce the principal amount due. The court cited language from the note that stated that “in lieu of simple interest payment”
the trainer has the “option to waive the monthly training fees for two (2) of [owner’s] horses.” The court stated that a reasonable interpretation of the language did not support the meaning advanced by the trainer.

Second, the trainer argued that the because the retail value of training provided far exceeded the 4% simple interest rate, the note was unlawful because the trainer was paying an effective interest rate of 18% and that such a rate was usurious. The court again rejected the trainer’s position. The court held that “[w]here the excessive interest is caused by a contingency under the debtor’s control, the transaction will not be deemed usurious.” Therefore, because the trainer elected to provide free training rather than pay the non-usurious rate of 4%, the note was lawful.

Nelson v. McFall, 2016 U.S. Dist. LEXIS 96895 (E.D. Cal. July 22, 2016)

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Bankruptcy Trustee Seeks to Recharacterize Litigation Financing Contract as Loan, Survives Motion to Dismiss

A litigation finance firm advanced funds to an attorney working a personal injury case on contingency. The attorney ultimately settled the case and was awarded a portion of the settlement as his fee. Following the settlement award, the attorney’s creditors, including the litigation finance firm, filed a petition to place the attorney in an involuntary bankruptcy to recover amounts due.

Rather than distributing funds to the finance firm, however, the bankruptcy trustee commenced an adversarial proceeding against the firm to recover any settlement funds that the firm had received or sought to recover from the attorney. The trustee argued that even though the transaction was couched as a purchase and sale of future income, it was in fact a loan that carried a usurious interest rate.

The trustee focused on portions of the agreement that it claimed exposed the transaction as a loan rather than a purchase and sale. Specifically, the trustee highlighted the agreement’s disclosure tables that referred to certain monetary transfers as “Amount of [finance firm]’s Interest/Amount Due to [finance firm].” The trustee claimed that the use of the term “interest” indicated that transaction was in fact a loan.

The finance firm filed a motion to dismiss the trustee’s claims arguing that the clear and unambiguous terms of the agreement controlled  and that the transaction was a true sale. The firm challenged the trustee’s interpretation and argued that the term “interest” was being taken out of context as it actually referred to the firm’s right to a portion of any future contingency fees the attorney ultimately received.

After reviewing the trustee’s allegations and the language of the agreement, the bankruptcy court denied the firm’s motion. The court stated that the use of the term “interest” was enough to introduce sufficient ambiguity into the agreement so that parol evidence could be considered to interpret the nature of the transaction.

Standish v. P. Rodney Jackson & LAC, LLC (In re Albertson), 548 B.R. 715, 2016 Bankr. LEXIS 1060 (Bankr. S.D. W. Va. 2016)

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Appellate Court Permits Use of Parol Evidence to Support Usury Defense

Two New York debtors entered into a promissory note with a lender in which the lender agreed to lend $35,000 to the debtors and the debtors promised to repay the lender $35,000 plus 15% interest. When the debtors failed to make the required payments, the lender filed suit for breach of contract.

In response, the debtors argued that the note was illegal because it charged an interest rate that exceeded the 16% maximum rate permitted by New York law. In support of their argument, the debtors provided a copy of a check payable from the lender to the debtors in the amount of  $30,000. The debtors explained that the other $5,000 had been withheld as a “loan fee.” Given that the 15% rate was charged on $35,000 instead of the $30,000 the debtors alleged they had received, the debtors claimed that the actual rate charged was 17.5%. The lender did not dispute the debtors claims but argued that the allegations should be excluded as parol evidence because the promissory note was complete on its face. The trial court agreed with the lender and granted it summary judgment. The debtors appealed.

The appellate court explained that while parol evidence is generally inadmissible to vary the terms of a promissory note that is otherwise clear on its face, it is admissible to show that a contract is illegal. In the present case, the debtors had alleged the affirmative defense of usury and therefore carried the burden of proving the existence of a usurious rate. The appellate court held that the debtors were entitled to submit the parol evidence to meet their burden of proof. Otherwise, the court reasoned, usury laws could be easily avoided through the use of fully integrated contracts.

The appellate court, therefore, denied the lender’s motion for summary judgment.

Stransky v DiPalma, 137 A.D.3d 1734, 28 N.Y.S.3d 548, 2016 N.Y. App. Div. LEXIS 2231, 2016 NY Slip Op 02254 (N.Y. App. Div. 4th Dep’t 2016)

 

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Supreme Court Denies Madden v. Midland Funding Cert. Petition

The Supreme Court has denied Midland Funding’s petition for certiorari. As a result, the 2nd Circuit’s holding that nonbank assignees are not entitled to NBA preemption if they are not acting on behalf of a national bank will remain binding law on the three states that make up the 2nd Circuit. The case, however, is still on ongoing. It will now remanded to the district court to decide whether or not to enforce the parties’ Delaware choice of law provision. If the provision is enforced, Midland should be successful in arguing that the interest rate it charged was not usurious. In its brief, the Solicitor General argued that there’s a good possibility that the district court will decide that issue in Midland’s favor which would result in the case being dismissed.

However, even if the case were dismissed, the 2nd Circuit’s holding on NBA preemption will still be binding. Assignees of national banks litigating in the circuit must now convince lower courts to disregard the 2nd Circuit’s decision or sufficiently distinguish the facts of their own cases such that district court judges feel comfortable not following Madden’s holding.

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Plaintiff Awarded Treble Damages for Usurious Interest Charges

A mother pawned some jewelry and coins in exchange for a loan which carried an interest rate of twenty percent per month. After the mother died, her son attempted to regain possession of the pawned items. The pawnbroker refused to return the items until the full balance due on the loan was repaid. Because the son believed the loan transaction to be usurious, he refused to pay the outstanding balance. The pawnbroker later sold a portion of the items. The son, as executor of his mother’s estate, then filed suit against the pawnbroker and alleged claims of state law conversion and federal RICO violations, among other actions.

The son moved for summary judgment against the pawnbroker and the US District Court judge granted the motion as to the conversion and RICO claims. In his motion, the son had also requested treble damages. After reviewing the case, the judge granted his request for treble damages as to the RICO claim but denied it for the conversion claim.

The Court explained that the federal RICO statute provides that any person injured as a result of a RICO violation is entitled to treble damages. To recover treble damages, a plaintiff must show that the defendant’s RICO violation actually caused the plaintiff’s injury. The Court held that the usurious interest rate (which constituted the collection of an unlawful debt and therefore meet the definition of a RICO violation) had directly resulted in the mother paying more interest than legally authorized. As a result, the Court granted the son’s request for treble damages.

The Court, however, denied the son’s request as to the conversion claim. The Court found that because the son had not offered evidence that the usurious interest rate had prevented the recovery of his mother’s property, he had failed to prove that the pawnbroker’s RICO violation had caused the damages related to the conversion claim. Therefore, the son’s request for trebling of the conversion damages was denied.

Gilmore v. Pawn King, Inc., 2016 U.S. Dist. LEXIS 39089 (D. Conn. Mar. 25, 2016)

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Proposed Legislation Would Delay Issuance of CFPB Payday Loan Rules

The CFPB is expected to propose its new payday loan rule next week. The rule is expected to significantly curtail payday loan products that charge more than 36% interest. Legislation recently proposed by South Carolina Representative John Mulvaney would delay the Bureau’s issuance and enforcement of a final rule.

Titled the “State and Tribal Government Sovereignty Protection Act of 2016,” the proposed bill would prevent the CFPB from issuing or enforcing any rule or regulation with respect to payday loans, vehicle title loans, or other similar loans for a period of 2 years. The bill would also require the Bureau to carry out a study to determine the agency’s legal authority to preempt state and tribal laws and regulations, the effect its payday loan rule would have on state and tribal law, and identify alternative proposals that would mitigate the risks posed by payday type financing without infringing on state and tribal sovereignty or preempt state and tribal laws.

The Bureau would be required to issue a public report that contained all of its findings. The report would also list all state or tribal laws that the Bureau’s proposed rule would preempt and name all state or federally recognized Indian tribes that the Bureau believes is incapable of protecting its citizens from the risks of payday lending.

States and tribal governments would also have the ability to opt-out of the CFPB’s payday loan rule. The opt-out would last for 5 years and could be continuously renewed.

Read the full bill here.

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Court Finds Contract to Be Sale of Property Not Loan of Money, Usury Claim Rejected

A buyer purchased an apartment from a seller. The contract for deed required the buyer to make a down payment and 180 equal monthly payments of amortized principal and interest.  Following the last payment, title to the apartment would pass from seller to buyer.

The seller later sold the apartment to a bank by a special warranty deed that conveyed the property and all rights of the seller under the contract for deed. When the buyer later defaulted on the contract for deed, the bank’s servicer foreclosed on the property. In response, the buyer filed suit alleging that the contract for deed was usurious. The trial court agreed. The servicer appealed.

After reviewing the record, the appellate court reversed the trial court’s decision. It explained that to establish usury, the buyer was required to prove: (1) a loan of money; (2) an absolute obligation to repay the principal; and (3) the exaction of a greater
compensation than is allowed by law for the use of the money by the borrower. The court noted that the Texas finance code defines a loan as “an advance of money that is made to or on behalf of an obligor, the principal amount of which the obligor has an obligation to pay the creditor.”

Based on this definition, the court found that the contract for deed was not a loan because the buyer had not received a loan of money. Further, there was no absolute obligation on behalf of the buyer to repay principal. And lastly, the court held that the sale of the contract for deed by the seller to the bank was a sale of a note at a discount and not a loan. Therefore, the buyer’s usury claim failed as a matter for law.

If the facts of this case sound somewhat familiar that’s because they are.

Bayview Loan Servicing, LLC v. Martinez, 2016 Tex. App. LEXIS 2326 (Tex. App. Dallas Mar. 3, 2016)

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Erroneous Interest Calculation Dooms Criminal Usury Defense – Part II

As previously discussed, the method used to calculate an interest rate is a critical part of any usury action. This was again highlighted in a recent a New York state case. The plaintiff had filed an action to recover on a loan it had made to the defendant. As part of its defense, the defendant argued that the loan violated New York’s criminal usury statute. The trial court rejected the defendant’s usury argument and granted summary judgment in favor of the plaintiff.

On appeal, the reviewing court affirmed the trial court’s decision. The reviewing court took issue with the defendant’s method of calculating the effective interest rate of the loan. To reach an effective rate that exceeded the criminal maximum, the defendant had included as interest “points” paid to the loan broker. The court rejected this interpretation. Instead, the court only included the points paid to the lender as interest. After reducing the amount of interest by the broker’s share of the points, the court found that the effective rate was under the 25% criminal cap.

This case reflects the differences between the calculation method used to determine an interest rate for the purposes of a usury statute and the method used by the Truth In Lending Act to calculate the APR of a consumer transaction. The calculation of the APR requires the determination of the “finance charge” of a transaction. Many costs and fees that may be included in the finance charge, such as broker’s fees, would not be considered interest for the purpose of calculating an interest rate in a usury case.

Marie Holdings, Inc. v Biclyn Corp., 26 N.Y.S.3d 462, 2016 N.Y. App. Div. LEXIS 1595, 2016 NY Slip Op 01602 (N.Y. App. Div. 1st Dep’t 2016)

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US District Court Decision Casts Doubt on Applicability of NBA Preemption to Bank Partners

The recent decision in Edwards v. Macy’s Inc. from a US District Court in New York seemed to provide reassurance that NBA preemption extends to non-bank agents acting on behalf of a national bank. In the Edwards decision, the court relied on Madden v. Midland Funding for its finding that “the Second Circuit has indeed held that [NBA] preemption extends to an entity that is not a national bank only where that entity is an agent or subsidiary of a national bank or is otherwise acting on behalf of the national bank in carrying out the bank’s business.” This holding is the metaphorical silver lining of the Madden decision, which has become a significant cause of concern for companies in the financial services industry.

A US District Court in Pennsylvania, however, issued an opinion earlier this week that casts doubt on the applicability of NBA preemption to non-bank agents. In the Pennsylvania case, a credit card holder filed a putative class action against a national bank and its department store agent. The cardholder alleged that the defendants had charged her for two ancillary card services that she had not requested or authorized.

Among other defenses, the department store argued that the NBA preempted some of the plaintiff’s claims against it because the store only serviced the cardholder’s account on behalf of the bank and was, therefore, acting as an agent of a national bank. As support for its argument, the store relied on the Supreme Court’s decision in Watters v. Wachovia Bank, N.A, 550 U.S. 1 (2007), which held that the NBA preempted state-law claims against the non-national bank subsidiaries of national banks if such claims would significantly impair the national banks’ ability to carry out their authorized banking activities. The Supreme Court’s holding was extended by subsequent Circuit Court decisions to claims against non-bank agents acting for national banks.

Despite the Supreme Court’s prior holdings, the Pennsylvania District Court refused to apply NBA preemption to the department store. The Court explained that provisions of the Dodd-Frank act had narrowed NBA preemption for national banks and eliminated it all together for non-bank subsidiaries, affiliates and agents. The Court cited 12 U.S.C. 25B(h)(2) as statutory authority for the elimination of non-bank preemption. That section states:

No provision of [the NBA] or section 24 of the Federal Reserve Act (12 U.S.C. 371) shall be construed as preempting, annulling, or affecting the applicability of State law to any subsidiary, affiliate, or agent of a national bank (other than a subsidiary, affiliate, or agent that is chartered as a national bank).

The Court also cited to a OCC interpretive letter which noted that “[t]he [Dodd-Frank] Act eliminates preemption of state law for national bank subsidiaries, agents and affiliates.” Based on the new statutory language, the District Court held that “the Dodd-Frank Act effectively overturned the subsidiary-preemption holding in Watters” and the Circuit Court decisions that extended its holding to non-bank agents. Therefore, the Court rejected the store’s argument that the claims against it were preempted by the NBA.

Though well reasoned, the District Court’s holding stands in direct conflict with the findings in Madden and Edwards to the extent that those decisions hold that NBA preemption extends to non-bank agents acting on behalf of a national bank. This growing uncertainty in the area of NBA preemption further highlights the appropriateness for the Supreme Court to grant the petitioner’s request for certiorari in Madden. 

Gordon v. Kohl’s Dep’t Stores, 2016 U.S. Dist. LEXIS 40008 (E.D. Pa. Mar. 28, 2016)

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