USURY AND WHEN IS A LOAN A LOAN
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.”
