Increased Value of Pledged Stock Not Interest

A lender provided a $600,000 loan to a borrower on the condition that the proceeds be used to purchase shares of a publicly traded company. The note provided for an interest rate of 10% and granted the lender warrants to purchase the shares at a fixed price. Upon the maturity of the note, the borrower had the option of repaying the principal plus interest or delivering the shares to the lender plus a cash payment of interest.

When the note came due, the borrower elected to deliver the shares to the lender. At the time the lender took ownership of the shares, their value had increased to more than $2 million. The borrower later filed a breach of contract action against the lender arguing that the value of the stock received by the lender in excess of the principal plus New York’s criminal usury rate of 25% should have been refunded to the borrower. The US District Court dismissed the borrower’s claim as barred by the one-year statute of limitation period on claims of overcharged interest. The borrower appealed to the Second Circuit.

Reviewing the District Court’s decision de novo, the Court of Appeals affirmed the District Court’s decision, though not on the same grounds (in a footnote, the Court appeared to reject the conclusion that the borrower’s claims was barred by the statute of limitations). Rather, the Court of Appeals found that the language of the note clearly removed the possibility that the transfer of the shares constituted a payment of interest.

“The contract provides that [the borrower] could elect to deliver the preferred shares to [the lender] to ‘repay the principal’ of the loan instead of paying back the $600,000 principal in cash. The contract specifically requires, however, that if [the borrower] chooses this alternative principal payment, she must make an additional “cash payment equal to the interest accrued . . . through the date of such delivery” at the regular, 10% per annum interest rate. There is no hint anywhere in the contract that to the extent the value of the preferred shares exceeded $600,000, that value would constitute payment of interest—in fact, the contract specifically contemplates that any interest must be paid in cash.”

Given the unambiguous language of the contract, the Court of Appeals rejected the borrower’s attempt to re-characterize the increase in the value of the shares as interest. As such, the court affirmed the District’s judgment.

Chassman v. Shipley, 2017 U.S. App. LEXIS 11252 (2d Cir. N.Y. June 21, 2017)

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U.S. District Court Holds that Purchase of Future Settlement Proceeds Violates Kansas Usury Law

A litigation finance firm advanced funds to an individual that was pursuing a personal injury case against a gas can manufacturer. After receiving a series of cash advances, the individual filed suit against the financing firm in U.S. District Court alleging that the financing agreements were unenforceable under Kansas law. The individual argued that even though the transactions were couched as purchase and sales of future proceeds of the personal injury case, they were in fact loans that carried usurious interest rates. The individual filed a motion for summary judgment.

In its opposition to the motion, the finance firm argued that the agreements were not subject to Kansas’ usury statute because repayment was contingent on the success of the individual’s case. If the individual failed to receive proceeds from his personal injury claim he would owe nothing. In support of its position, the firm cited a Kentucky Court of Appeals case which held,

Where, under a contract for the payment or repayment of money, the payment of interest on the principal sum is subject to a contingency, so that the creditor’s entire profit or return is put in hazard, the interest so contingently payable need not be limited to the maximum fixed by the usury statutes, provided the contract is made in good faith and without intention to evade or avoid the usury laws.

Dublin v. Veal, 341 S.W.2d 776, 777-78 (Ky. 1960).

After reviewing the individual’s motion and the firm’s opposition, the court granted summary judgment for the individual. The court held that even if the agreements were not loans (which it believed they were) the transactions were still subject to Kansas’ usury statutes. It stated, “[t]he statute never uses the term ‘loan’ in that subsection; rather it applies to ‘any contract or other obligation in writing where the original principal amount is fifteen thousand dollars ($15,000) or less . . . .’ KRS 360.010(1)(a). The scope of KRS 360.010(1) certainly encompasses the subject Agreements, each of which evidence indebtedness under $15,000.”

The court refused to follow the holding in Dublin because that case involved the sale of future business profits between co-partners in a commercial enterprise. In contrast, the court found that the transactions between the individual and the financing firm were simply loans of money “to tide him over while he litigated his personal injury claim.” As such, the court held that the agreements did not fit the exception discussed in the Dublin case and were, therefore, subject to Kansas’ usury statute.

Boling v. Prospect Funding Holdings, LLC, 2017 U.S. Dist. LEXIS 48098 (W.D. Ky. Mar. 30, 2017)

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Citing Madden v. Midland Funding, Colorado Regulator Challenges Bank Partnership Model

The Colorado Administrator of the Uniform Consumer Credit Code (UCCC”) has filed complaints against two UCCC licensees alleging violations of Colorado’s usury cap. Both licensees utilize bank partnerships to originate their loans.

Citing Madden v. Midland Funding, the Administrator, represented by the office of the Colorado Attorney General, alleges that the licensees may not charge interest rates that the banks were permitted to charge under federal law. As the Administrator argues,

Specifically, certain banks may, pursuant to federal law, lawfully lend in Colorado and other states at rates that exceed the interest and other finance charge limits imposed by state law. This right is sometimes referred to as federal interest rate exportation.

[The licensees], and other non-banks cannot, however, enforce a bank’s federal interest rate exportation rights when they purchase loans from banks (or purchase loan receivables) because banks cannot validly assign such rights to non-banks. E.g., Madden v. Midland Funding, LLC, 786 F.3d 246, 250 (2d Cir. 2015) (distinguishing contrary precedent, and holding that non-bank purchaser of national bank’s loan could not enforce bank’s right to federal interest rate exportation).

The Administrator also alleges that the licensees, rather than the originating banks, were the true lenders of the loans.

Further, with respect to the [licensee loans] that [the bank] sells to [licensee or licensee’s] affiliates (including loans in which [the bank] sells only the receivables), [the bank] is not the true lender of the loans and, because the loans therefore are not made by a bank, federal interest rate exportation does not apply for this additional reason. E.g. CashCall, Inc. v. Morrisey, 2014 W. Va. LEXIS 587 (W. Va. May 30, 2014) (memorandum decision) (national bank that sold loans to non-bank was not the true lender of the loans because the non-bank purchaser bore the predominant economic interest in the loans and non-bank purchaser therefore could not enforce bank’s right to federal interest rate exportation).

[The bank] is not the true lender of the [licensee loans] that it sells to [licensee or licensee’s] non-bank affiliates because [the bank] does not bear the predominant economic interest in the loans.

The Administrator requests relief in the form of: injunctive relief, refund and penalty payments to Colorado consumers, a civil penalty paid to the Administrator, and attorney’s fees.

The licensees have not yet filed their initial responses.

Meade v. Avant of Colorado LLC d/b/a Avant, & Avant, Inc., 1:17-cv-0620-WJM

Meade v. Marlette Funding LLC d/b/a Best Egg, 1:17-cv-00575-PAB

Posted in Assignor-Assignee, Attorney General, Colorado, Federal Court, National Bank Act, Preemption, Usury Cap, Usury Exceptions | Comments Off on Citing Madden v. Midland Funding, Colorado Regulator Challenges Bank Partnership Model

Massachusetts State Court Rejects Choice of Law Clause, Vacates Confessed Judgment

A business located in Massachusetts received financing from a small business funder. The parties’ agreement stated that in exchange for the financing provided, the funder would receive 15% of the business’ daily receipts which the funder would take by debiting $1,549 from the business’ bank account each business day. The business later defaulted on the agreement and the funder obtained a confessed judgment against it in New York.

The funder then domesticated the New York judgment in Massachusetts. A few days after the New York judgment was domesticated, the business filed a motion to vacate the judgment in Massachusetts. The business argued that the underlying judgment was void because it was obtained pursuant to a confessed judgment provision in a promissory note which is not permitted under Massachusetts law. The business alleged that the loan itself was void because it violated the criminal usury laws of New York and Massachusetts. The business also argued that because the loan charged a rate greater than both states’ criminal usury caps the transaction violated Massachusetts’ UDAP statute.

After reviewing the parties agreement, the court granted the business’ motion and vacated the Massachusetts judgment. In a somewhat disjointed discussion, the court appeared to disregard the agreement’s New York choice of law provision as it related to the enforceability of the confessed judgment provision. The court stated, “while Massachusetts is required to give full faith and credit to lawfully executed judgments from other states, these all appear to be Massachusetts agreements…Here, the agreements were executed in Massachusetts, by Massachusetts residents and Massachusetts businesses, through a Massachusetts notary.”

To support its rejection of the agreement’s New York choice of law, the court held that the funder had failed to offer any explanation as to how the agreement was not a “Massachusetts Agreement.” However, the court did note that the parties agreement specifically provided that the “Agreement [would] be governed by and construed in accordance with the laws of the state of New York, without regards to any applicable principals of conflicts of law [and that] [a]ny suit, action or proceeding arising hereunder, or the interpretation, performance or breach hereof, shall, if [the funder] so elects, be instituted in any court sitting in New York.” Yet despite its clear language, the court appeared to limit the scope of the agreement’s choice of law provision to only cover the venue in which the funder could bring a complaint, “[The funder] chose the venue in its Merchant Agreement and appropriately filed its Complaint in New York.” As a result, the court seemed inclined to believe the confessed judgment provision was void under Massachusetts law and, therefore, refused to recognize the New York judgment.

The court further held that even if a judgment by confession were permitted under Massachusetts law, the funder had failed to refute the business’ allegation that the agreement appeared to charge an interest rate that exceeded the criminal usury laws of Massachusetts and New York. The court stated that the funder had failed to show how the $1,549 daily payment, which the court interpreted as a “DAILY interest rate”, was not criminally usurious under New York and Massachusetts law. In so finding, the court appeared, without any analysis, to hold that the transaction was a loan and to reject the plain meaning of the agreement which stated that a confessed judgment would bear an interest rate of 16%.

As a result, the court vacated the Massachusetts judgment.

Saturn Funding, LLC v. NRO Boston, LLC, 2017 Mass. Super. LEXIS 3 (Mass. Super. Ct. Feb. 21, 2017)

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Citing Growing Body of Case Law, 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 a portion of the business’ daily proceeds until the funder received the total amount of purchased receivables.

The business later sued the funder and the bank that had initiated the ACH debits from the business’ bank account on the funder’s behalf. In its complaint, the business alleged that the transaction was not a purchase and sale but rather a usurious loan. In response, the bank filed a motion to dismiss the suit.

After reviewing the business’ complaint the trial court granted the motion. In its decision, the court cited a number of recent cases that had found that the sale of future receivables is not subject to New York’s usury laws. The court stated,

“…the agreement between the parties is unquestionably a purchase of receivables, and hence, not a loan, to which the laws of usury apply. This was established in Merchant Cash & Capital v Edgewood Group, LLC, 2015 U.S. Dist. LEXIS 94018, 2015 WL 4451057 (U.S.D.C., S.D.N.Y, Koeltl, J.), [**4]  Merchant Cash & Capital, LLC v Yehowa Med. Servs., Inc., 2016 NY Misc. LEXIS 3065 *, 2016 NY Slip Op 31590(U) [Sup Ct. Nassau Co. 2016; Murphy, J.]); Merchant Cash & Capital, LLC v Liberation Land Co., LLC, 2016 NY Misc. LEXIS 4854, 2016 NY Slip Op 32589(U) [Sup Ct. Nassau Co. 2016; Mahon, J.]; Retail Capital, LLC. d/b/a Credibly v Spice Intentions Inc. d/b/a Curry Heights, and AK M Karim, Index No. 713376/15, 2016 N.Y. Misc. LEXIS 4883, 2016 NY Slip Op 32614(U), Sup. Ct. Queens Co. [2016; this Court]) and other courts facing this issue.”

The court further held that the business, which was a corporation, was barred by General Obligations Law §5-521(1) from interposing the defense of civil usury, and could not assert criminal usury as a cause of action, rather than as an affirmative defense.

As a result, the court found that the business’ suit was without merit and dismissed the case.

Chartock v National Bank of California, 2017 N.Y. Misc. LEXIS 673 (N.Y. Sup. Ct. Jan. 17, 2017)

Posted in Civil Usury, Criminal Usury, Merchant Cash Advance, New York, Sale vs. Loan, State Court | Comments Off on Citing Growing Body of Case Law, New York Court Finds Sale of Future Receivables is Not Subject to Usury Laws

In Three Separate Decisions, New York Courts Find Sale of Future Receivables Not Subject to Usury Laws

In three nearly identical cases, a small business funder entered into an agreement with three separate businesses to purchase a portion of the businesses’ future receivables for an upfront lump sum. In exchange for the lump sum payment, the funder was to receive a portion of the businesses’ daily proceeds until the funder received the total amount of purchased receivables.

Each of the businesses breached their agreements by refusing to forward the purchased receivables to the funder. As a result, the funder filed complaints for breach of contract against the three businesses. In each of their answers, the businesses argued that the transactions were not true purchase and sales but rather usurious loans. In response, the funder filed motions to dismiss the businesses’ usury defenses.

After reviewing the businesses’ arguments the trial courts granted the funder’s motion and dismissed the usury defenses. First, the courts held that the businesses and their individual guarantors were barred from asserting civil usury because that defense is unavailable to corporate entities in New York. Second, the courts found that businesses’ had failed to sufficiently allege criminal usury defenses because they failed to allege that the funder had knowingly charged, took or received annual interest in excess of 25% on a loan or forbearance.

The courts 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. In each case the courts specifically found that the agreement between the parties was a purchase of future receivables for an upfront payment. In one of the cases, the court 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, each of the three courts found that the businesses’ arguments were entirely without merit and granted the funder’s motion to dismiss the usury defenses.

Merchant Cash & Capital, LLC v Liberation Land Co., LLC, 2016 N.Y. Misc. LEXIS 4854, 2016 NY Slip Op 32589(U) (N.Y. Sup. Ct. Dec. 12, 2016)

Merchant Cash & Capital, LLC v South Jersey Speed LLC, 2016 N.Y. Misc. LEXIS 4852, 2016 NY Slip Op 32591(U) (N.Y. Sup. Ct. Dec. 13, 2016)

Merchant Cash & Capital, LLC v Fire Suppression Servs., Inc., 2016 N.Y. Misc. LEXIS 4855, 2016 NY Slip Op 32590(U) (N.Y. Sup. Ct. Dec. 16, 2016)

Posted in Civil Usury, Criminal Usury, Merchant Cash Advance, New York, Recharacterization, State Court | Comments Off on In Three Separate Decisions, New York Courts Find Sale of Future Receivables Not Subject to Usury Laws

Convertible Note with 150% Default Penalty Not Usurious

A creditor purchased four convertible promissory notes from a company. The notes provided that they could be converted to unrestricted common stock of the company at a 45% discount. Upon an event of default, the notes carried a penalty that required a payment from the company of 150% of the outstanding balance of the notes.

Following an event of default, the creditor elected to convert the notes to stock and filed a suit for breach of contract for the 150% penalty. In response, the company argued that the notes charged rates that exceeded New York’s criminal usury code and that the discounted price at which the creditor obtained the company stock rendered the transaction usurious. The company then moved for summary judgment based on its usury defense. The trial court, however, rejected the company’s arguments.

The trial court explained that even though the notes provided for a discounted conversion rate of 45%, that alone did not render the transaction usurious. “…[G]iven that the shares could fluctuate in value, and the value realized would be paid by a buyer and not the [company], it is difficult to imagine that the share price discounts contained in the agreement could reasonably be construed as interest, and how one would calculate the rate of such interest.”

Further, the court held that the 150% penalty charged on the outstanding balance was not a violation of the New York usury code because its assessment was within the control of the company, specifically whether or not it defaulted on the notes.  In support, the court cited to a 2015 2nd division appellate decision, “a payment may not be considered usurious where, as here, said payment is ‘based upon a contingency within the control of the debtor—in this case, default in the payment of an agreed-upon obligation—and the debtor could have avoided the imposition of such charges simply by paying promptly.'”

Therefore, the court denied the company’s motion in its entirety.

KBM World Wide, Inc. v. Hangover Joe’s Holding Corp., 2017 U.S. Dist. LEXIS 15003 (E.D.N.Y. Feb. 1, 2017)

Posted in Criminal Usury, Federal Court, Interest Calculation, New York | Comments Off on Convertible Note with 150% Default Penalty Not Usurious

Despite Criminal Usury Claim, Court Compels Arbitration

A New York resident sued an alternative small business lender for, among other counts, criminal usury related to small business financing that the resident’s business had received and that the resident had agreed to guarantee. The agreement included a provision that required that “all claims brought by the signing principal, as well as the business itself” be resolved by arbitration. In response to the complaint, the lender filed a motion to compel arbitration as provided by the agreement.

In its decision, the court explained that “[u]nder the FAA [Federal Arbitration Act], a court must compel arbitration if it finds that: (1) a valid arbitration agreement exists between the parties; and (2) the dispute before it falls within the scope of the agreement.” After reviewing the facts of the present case, the court found that “here, [the resident], as owner of [the business] and as personal guarantor, signed the Agreement, manifesting his intent to be bound by the Agreement’s terms and its arbitration provision.” Additionally, the court held that the resident’s personal guaranty of the financing was subject to the arbitration provision.

Therefore, the court granted the lender’s motion and stayed the case pending the completion of the arbitration.

Caudill v Can Capital, Inc., 2017 N.Y. Misc. LEXIS 9, 2017 NY Slip Op 30008(U) (N.Y. Sup. Ct. Jan. 3, 2017)

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Another New York Court Upholds Bar on Corporate Usury Defense

A welding company sold a portion of its future business receivables to an MCA provider for a lump sum purchase price. When the welding company failed to remit the purchased sale proceeds as required by the parties’ agreement, the MCA provider filed suit against the company and its owner that had signed as a personal guarantor.

As a defense, the defendants argued that the transaction was not a true purchase and sale of future receivables but rather a disguised loan with a usurious interest rate. In response, the MCA provider filed a motion to dismiss the defendants’ usury defense and argued that because the transaction was not a loan or forbearance the defense was meritless. In opposition to the motion to dismiss, the welding company urged that the motion was premature as discovery had not yet been completed and that an affirmative usury defense could not be dismissed until discovery is completed. The court disagreed.

In its order dismissing the defendant’s usury defense, the court held that a plaintiff may move at any time to dismiss an affirmative defense if the defense is without merit. Reviewing the facts before it, the court held that the company, as a corporation, could not interpose the defense because under New York law corporations are barred from asserting the defense of civil usury. Further, the court found that an individual guarantor is also precluded from raising the defense. As such, the court held that the defendants’ argument that the agreement was usurious was meritless and dismissed their defense.

Merchant Cash and Capital, LLC, Plaintiff, v. Hobby Horse Welding, Inc., and Robbie Jo Carpenter, Defendants., 2016 N.Y. Misc. LEXIS 4894 (N.Y. Sup. Ct. Dec. 21, 2016).

Posted in Merchant Cash Advance, New York, Sale vs. Loan, State Court | Comments Off on Another New York Court Upholds Bar on Corporate Usury Defense

New York Court Enforces Choice of Law Provision Despite State Usury Law

An alternative small business lender provided a loan to a business. The business later filed suit against the lender in an attempt to void the loan agreement. The business alleged that the agreement violated New York’s criminal usury statute.  The agreement contained a choice of law provision which provided that the transaction would be interpreted and governed by Utah state law.

The lender filed a motion to dismiss the complaint arguing in part that the agreement’s choice of law provision was enforceable and that under Utah state law the loan was not usurious. The court agreed, stating,

Hornbook law holds that Courts must enforce choice-of-law provisions, at least if there is a reasonable connection between the law chosen and one of the parties. Here, defendants, one of which is located in Utah, and the transaction, which defendants claim, without contradiction, was “made” in Utah, obviously have a strong connection to Utah. Thus, the choice-of-law provision is enforceable, and the agreement is not void based on New York’s usury law.

As a result, the court granted the lender’s motion and dismissed the case.

Parry v Retail Capital LLC, 2017 N.Y. Misc. LEXIS 154, 2017 NY Slip Op 30082(U)

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