There is a common perception that usury is not much of a concern for loans made in New York. And, if the loan is in a principal amount over $2.5 million, that perception is a fairly safe one. But for loans under $2.5 million, New York actually has a complicated usury regime, and the consequences of running afoul of it can include the forfeiture of the full principal amount of the loan. Indeed, charging more than 25% interest on a loan of less than $2.5 million is an actual crime in New York.
Easy enough you say, just make sure you don’t charge more than the maximum allowable rate if you have a New York loan with a principal amount less than $2.5 million. But “interest” is not limited to just the stated rate. Indeed, interest is anything that is obtained by the lender in consideration for the making of the loan. And, according to a recent opinion from New York’s highest court, that can include the value of a conversion option built into the loan arrangement.
In Adar Bays, LLC v. GeneSYS ID, Inc., 2021 WL 4777289 (N.Y. Oct. 14, 2021), the New York Court of Appeals answered certified questions submitted to the court by the United States Court of Appeals for the Second Circuit concerning the operation of New York’s usury law. One of the certified questions was this: “Whether a stock conversion option that permits a lender, in its sole discretion, to convert any outstanding balance to shares of stock at a fixed discount should be treated as interest for the purpose of determining whether the transaction violates N.Y. Penal Law § 190.40, the criminal usury law.” And the answer given by the New York Court of Appeals to this question was an unequivocal Yes.
Prior to this recent decision by the New York Court of Appeals, the law was apparently less than clear on this point. Some New York lower court decisions courts, as well as federal district courts applying New York law, had “generally concluded that a conversion option at a discounted rate d[id] not violate usury laws.” These cases seemed to be premised on the view that the value of such a conversion option was too speculative to be determined, or on the view that once converted the loan was an investment, rather than a loan, and the usury laws did not apply. But the New York Court of Appeals clarified that New York law “requires [and has always required] that the value of the conversion option, like all other property exchanged in consideration for the loan, should be included in determining the loan’s interest rate for purposes of the usury statutes, to the extent such value, when measured at the time of contracting, can be reasonably determined.”
The loan in question in Adar Bays was a $35,000 convertible note issued by a public company that had a stated rate of 8% per annum, and a maturity date of one year. Apparently, this note was part of a series of notes that the company had issued to other lenders/investors. The note provided the lender the option to convert all or any portion of the note into the public company’s stock at 65% of the lowest trading price of that stock for the preceding 20 days, at any time after 180 days from the date the note was issued. When the lender in fact sought to exercise this option, the borrower public company refused to so convert and, when sued for breach of contract, defended itself based on usury. And according to the New York Court of Appeals, as long as the borrower public company can prove the value that the discounted conversion option had at the date the loan was made (which the court thought was a fairly straight forward valuation exercise), the value of the discounted conversion option must be added to the stated rate of interest for the purpose of determining whether the loan exceeded the criminal usury rate of 25%. If the borrower is successful in establishing the value of the conversion option when added to the stated rate exceeds 25% per annum, the lender cannot collect any portion of the loan whether principal or interest—a harsh result, but one the court believes was intended by the New York legislature in establishing its criminal usury regime.
While a loan arrangement of less than $2.5 million may be rare in the private equity industry, they do occur. And, when they do, avoid the temptation to assume that New York is the obvious choice of law when another state’s law may be available to choose—one with a more liberal maximum rate, less punitive consequences, or no usury limit at all.
- The maximum civil usury rate in New York is 16% for loans under $250,000, unless the loan is to a corporation (but loans to corporations remain subject to the criminal usury limit). General Obligations Law §§ 5-501, 5-511, 5-521; Banking Law § 14-a(1); and Penal Law § 190.40.↵
- Adar Bays, LLC v. Genesys ID, Inc., 962 F.3d 86, 91 (2d Cir. 2020).↵
- See Glenn West, Usury Bites—A Refresher on an Easily Overlooked Issue in the Restructuring and Private Equity Arenas, Weil Insights, Weil’s Global Private Equity Watch, April 18, 2018, available here. But note that for loans made to individuals or general partnerships (as opposed to limited partnerships, corporations, limited liability companies and certain other business entities), in an amount less than $100,000 (or loans more than $100,000 that are secured by a borrower’s primary residence), Delaware does have usury limits. Delaware Code, Tit. 6 §§ 2301(c) and 2306.↵