Breach of Contract, Business Receipt Purchases, Loans, Usury
New York, like many states, provides a usury defense against enforcement of certain loans, which stated simply means that if the interest rate is too high, the borrower can avoid repayment. Usury applies to non-contingent loans (e.g. the lender has an absolute right to payment), and does not apply to investments where returns are based on future contingencies. Whether the subject transaction is truly a loan and the lender’s right to repayment is truly absolute are fact-intensive issues heavily litigated in cases with usury defenses concerning sophisticated transactions.
In broad strokes, the usury defense in New York for individuals covers loans in an amount between $250,000 and $2.5 million with an interest rate equal to or greater than 16% per year. For loans to corporate entities, usury applies to loans under $2.5 million with interest equal to or greater than 25% per year.
Transactions involving the “purchase” of future receivables can raise issues about whether the transaction is, or is not, truly a loan with an absolute right to repayment. Around ten years ago, in Clever Ideas, Inc. v. 999 Rest. Corp., Index No. 602302/06, we sued in the Commercial Division of the New York State Court to enforce two Advanced Meal Sales Agreements by which our client advanced $235,000 to a restaurant in exchange for $363,500 of future credit card receipts. We alleged the restaurant cut off the credit card payments, and sued for the balance due, interest and legal fees. The restaurant raised a usury defense claiming the transaction was a loan with repayment being assured given the high level of credit card payments and a personal guaranty. The restaurant claimed that given the expectedly short repayment time, the effective interest rate far exceeded 25%. The Court refused to summarily grant or deny the defense, and held a trial was needed to determine the fact issues, including whether the plaintiff intended for the interest rate to exceed 25% per year.
Nearly a decade later, New York courts still grapple with usury defenses in transactions involving repayment by future business receipts. In Colonial Funding Network, Inc. v. Epazz, Inc., No. 16 CIV. 5948 (LLS), 2017 WL 1944125 (S.D.N.Y. May 9, 2017), plaintiff alleges that, pursuant to three Merchant Cash Advance Agreements, it advanced the defendant-software company $600,000 in exchange for up to $900,000 of the software company’s future business receipts. Plaintiff would receive approximately $5,400 per day, but at the end of each month, plaintiff would either credit or debit the software company the difference between the amount received and 15% of the software company’s total monthly receipts.
The software company raised a usury defense relying on the decision in our Clever Ideas case, claiming repayment would be short and secure, and the effective interest rate was just under 50% per year. The Federal Court looked at the “real purpose” of the transaction and whether the transaction was “repayable absolutely.” The Court summarily dismissed the usury defense, carefully distinguishing Clever Ideas in finding the software company failed to show that the advance was repayable absolutely. Unlike in Clever Ideas, the amount of repayment could decrease and was conditioned on the amount of revenue the company generated (if any). The transaction was, thus, not a loan, and the Court expressly held “[i]f the transaction is not a loan, there can be no usury, however unconscionable the contract may be.”
Breach of Contract, Contracts, Modification, UCC
Oftentimes businesspeople sign a contract and put it in a drawer never to see the light of day again – unless a dispute arises. Especially with long-term contracts, trying to informally work things out might be efficient from a business perspective at the time, but it can lead to waiver of important legal rights in the end.
A 2017 decision by a New York appellate court, Kamco Supply Corp. v. On the Right Track, LLC , 149 A.D.3d 275, 49 N.Y.S.3d 721 (2d Dep’t 2017), certainly provided a wake-up call to anyone who believed in the casual administration of a contract. Kamco Supply Corp.concerned disputes arising out an approximately 18 month long distribution agreement. The intermediate appellate court held that the seller, by accommodating the underperforming purchaser, waived the right to enforce minimum purchase requirements for the construction product under the contract. The parties entered into the distribution agreement in mid-2005. The agreement required the purchase of 15 million feet of the product during the remainder of 2005 and ramped up dramatically to require purchase of 164 million feet in 2006 with a monthly minimum of 8 million feet. The purchaser agreed to use its “best efforts” to market, sell and distribute the product.
From the start, the purchaser failed to meet the 2005 purchase requirements, let alone the tenfold increased requirements in 2006. The seller did not default the purchaser, but instead tried to work with the purchaser. By May 2006, the purchaser opened discussions with the seller to end the relationship and, by July 2006, the seller recognized the purchaser would miss all purchase requirements. Regardless, the seller decided to stick with the purchaser as the seller’s best hope to increase sales of the product. By the end of 2006, in an act that surely stung, the nonperforming purchaser sued the seller for breach of contract in failing to refund $17,500. The seller countered with claims of breach of the purchase requirements seeking $71 million in damages.
The court focused on the importance of “course of performance” in “relational” contracts (i.e., contracts involving continuing relationships) in determining not only whether a party committed a retrospective waiver of a prior obligation, but also whether a party prospectively waived an executory, or future, obligation of the other party. The court held that where a contracting party waives an ongoing obligation, it may retract the waiver on reasonable notice and without undue prejudice to the counterparty. The case, involving the sale of goods, also triggered the Uniform Commercial Code, which recognizes the importance of course of performance in interpreting agreements and finding waiver of future rights. The court upheld the trial court’s finding that, despite an express “no waiver” provision in the contract prohibiting oral waivers, the seller by its conduct (i) waived the past due purchase requirements; (ii) made an election not to terminate the contract because of those breaches; and also (iii) waived the future purchase requirements because the seller failed to give timely notice withdrawing its waiver. The court dismissed the seller’s claims because the seller did not enforce the purchase requirements or make written reservations of rights and, instead, made accommodations to the purchaser in the hopes of increased sales.
The end result for the seller was that after 11 years of litigation (over seven times longer than the contract term), and after trial and appeal, the court granted the purchaser a $17,500 verdict on its breach of contract claim and dismissed the seller’s claims holding the seller waived the purchaser’s admitted breaches of every purchase requirement in the contract. This case provides a cautionary tale that contracting parties should avoid informal changes, and instead enforce their contracts and document amendments and new understandings.
While the above presents an extreme situation, you might face a less severe situation that could still result in a court later finding you waived your rights by failing to enforce your contract rights or by making oral changes without reservations of rights and proper documentation. If you have any questions about your contractual relationships and how you can best protect your business (whether to enforce or avoid a particular contract), please do not hesitate to contact us.
