New York Usury Statutes and the Adar Bays Decision
As is the case in many states around the U.S. and the world, New York State has usury laws that prohibit lenders from charging borrowers high rates of interest on loans. A recent case in New York has shed light on what may constitute interest for the purposes of the New York usury statutes.
New York Criminal and Civil Usury Statutes
A loan violates the civil usury statute if the interest is above 16% and violates the criminal statute if the interest is above 25%. However, various exceptions apply. For example, neither statute applies to loans above $2.5 million. Further, generally loans of $250,000 are more are exempt from the civil statute as well.
What is the effect of the Adar Bays decision?
In the loan at issue in Adar Bays, Adar Bays LLC gave GeneSYS ID, Inc a $35,000 loan with 8% interest. As part of the loan, there was an option to convert the debt into stock at a 35% discount. Adar Bays attempted to exercise this option, but GeneSYS refused to comply, at which point Adar Bays sued in the Southern District of New York. GeneSYS argued that the loan was void because the interest and conversion rate was over 25%.
The New York Court of Appeals held that a conversion price in a convertible option can be interest, and therefore violate New York’s criminal usury laws. As a result, in loans between $250,000 and $2.5 million, commercial lenders must cap any conversion price in convertible options so that they are under 25% or their loans could be declared void. The New York Court of Appeals also clarified that the affirmative defense of criminal usury can be raised in a civil case. The court listed various factors in determining whether a transaction is a loan including whether the parties are directly exposed to market risk in the value of the underlying assets. If they are not directly exposed, they are likely to be lenders, not investors. Another factor is whether a party applied to the other for a loan and whether there were preexisting transactions between the parties. The court noted that this helps distinguish between an intent to borrow and the intent to change money for other reasons.
Using these factors, the court determined that the conversion price at issue in Adar Bays was a loan. Although the court stated that “the mere fact that a fixed price future conversion option may be exercised at a future usurious rate does not render the loan usurious on its face”, the court noted that “Adar Bays is a lender, GeneSYS a borrower, and the parties executed a traditional loan instrument – the note – constituting a promise by GeneSYS to pay the loaned principal, plus interest, in some form by the maturity date. The transaction, at its inception, was plainly a loan.” As a result, the entire loan instrument was voided.
What are the Penalties for Violating New York’s Usury Laws?
If found to violate the usury statutes, loans “are subject to the same consequence as any other usurious loans: complete invalidly of the loan instrument.”
Important Considerations for Shipping Lenders
First, lenders should know that savings clauses may not protect them. Although loan agreements generally include a “savings clause” which provide for a lower interest rate if the original rate violates the law, they are not guaranteed to protect the lender. Further, partial payment cannot ratify the loan, nor can a lender’s agreement to waive all interest allow collection of the principal.
Second, as mentioned, a loan in excess of $2.5 million is not subject to New York’s usury statutes. Since only relatively small loans apply, many commercial loans, including ship financing loans, do not fall within the reach of the statutes. However, because the statutes often don’t apply, they are often not on a lender’s radar. It is important to keep in mind that such limitations do exist in order not to run afoul and suffer devastating consequences.
Finally, a lender should consider which jurisdiction’s usury laws may apply because depending on the circumstances, the laws of the jurisdictions where the borrower (or lender) is located or has a significant nexus may come into play. It may not be sufficient to check the governing law of the contract.
Please contact any member of S&K’s Maritime Practice Team.