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)

About Patrick Siegfried

Patrick Siegfried is the author of the Usury Law Blog. Patrick is a practicing attorney in Bethesda, Maryland. Patrick’s work focuses on issues regarding alternative small business financing. He can be reached at psiegfried@usurylawblog.com

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