New York State Court of Appeals Rules Usurious Loans Void Ab Initio | Bond Schoeneck & King SARL
In a recent case, the New York Court of Appeals answered a new question posed to it by the United States Court of Appeals for the Second Circuit regarding the intersection of the New York General Obligations Act and New York criminal law. That question was: where interest charged on a loan is found to be criminally usurious under New York Criminal Law § 190.40, is the underlying contract void in its entirety pursuant to NY Gen. Oblig. Law § 5-511? The Court answered that question in the affirmative in a decision that has significant implications for corporations and lenders in New York.
In Adar Bays, LLC v GeneSYS ID, Inc., 37 NY3d 320 (2021), plaintiff Adar Bays, LLC granted defendant GeneSYS ID, Inc. a loan of $35,000, with an interest rate of 8% that would mature in one year. The loan agreement contained an option for Adar Bays to convert some or all of the debt into shares of GeneSYS at a 35% discount to the lowest trading price for shares of GeneSYS during the 20 days. preceding the date on which Adar Bays requested a conversion.
About six months after the loan was issued, Adar Bays exercised its option to request the conversion of part of the debt. GeneSYS declined, seeking instead to renegotiate the terms of the loan. Adar Bays sued GeneSYS for breach of contract. GeneSYS filed for dismissal of the lawsuit, saying the contract was void because the interest rate, including the conversion option, exceeded the criminal usury rate of 25%.
In reaching its conclusion, the Court of Appeals considered the provisions of the General Obligations Act, the Banking Act, and the Criminal Act, which together constitute New York’s usury law. The Court noted that under these provisions combined, loans of less than $250,000 to individuals cannot exceed an annual interest rate of 16% (the civil usury rate) and loans between $250,000 and $2.5 million cannot exceed 25% (the criminal usury rate). The Court further ruled that loans worth $2.5 million or more are not subject to usury laws.
The Court also held that if the civil usury defense contained in the New York General Obligations Act is not available to corporations, a corporate borrower may still invoke the criminal usury defense in a civil action. Specifically, although Section 5-521(1) of the General Obligations Act “prohibits” corporations from asserting the usury defense with respect to a loan bearing less than 25% interest , this restriction is inapplicable when an interest rate is higher than 25%. %, bringing the loan into the area of criminal law § 190.40.
Referring to the legislative history of the enactment of the Criminal Usury Act, the Court came to its final conclusion that loans with an interest rate above 25% should be canceled in their entirety because this would defeat the purpose of usury law to allow a lender to collect payments on a loan for which it could be sued for criminal usury. The Court held that it made sense that loans that violate criminal usury law should be subject to the same consequences as any other usurious loan – the complete invalidity of the instrument.
Another important question that was put to the Court in this case was whether a stock conversion option that allows a lender, at its sole discretion, to convert any outstanding balance into stock at a fixed discount should be dealt with as interest for the purpose of determining whether the transaction violates criminal usury law. The Court also answered this question in the affirmative.
the Adar berries decision should be interpreted as a warning to lenders to carefully consider the terms and conditions of its loan instruments. The potential consequences of including interest rate conditions that violate the principles explained by the Court of Appeal are significant.