Adar Bays, LLC v. Genesys Id, Inc.

• Decision Date: 26 February 2020
• Docket Number: August Term 2019,Docket No. 18-3023
• Citation: 962 F.3d 86
• Parties: ADAR BAYS, LLC, Plaintiff-Appellee, v. GENESYS ID, INC. FKA RX Sales, Inc., Defendant-Appellant
• Court: U.S. Court of Appeals — Second Circuit

962 F.3d 86

ADAR BAYS, LLC, Plaintiff-Appellee,

v.GENESYS ID, INC. FKA RX Sales, Inc., Defendant-Appellant

Docket No. 18-3023

August Term 2019

United States Court of Appeals, Second Circuit.

Submitted: February 26, 2020

Questions Certified: June 11, 2020

Kevin Kehrli, Garson, Segal, Steinmetz, Fladgate LLP, New York, NY, for Plaintiff-Appellee.

Jonathan Uretsky, Phillipson & Uretsky, LLP, New York, NY, for Defendant-Appellant.

Before: Parker, Livingston, Nardini, Circuit Judges.

Barrington D. Parker, Circuit Judge:

This appeal arises from an action brought by Adar Bays, LLC, against GeneSYS ID, Inc., to collect on a Convertible Redeemable Note ("Note") issued in connection with a loan from Adar Bays to GeneSYS, which had defaulted. The Note permitted Adar Bays to convert any outstanding loan balance into GeneSYS common stock at a 35% discount from the stock's market price. The primary issue presented is whether this conversion option meant that the Note's interest rate exceeded the 25% cap set by New York's criminal usury law, N.Y. Penal Law § 190.40.

In the court below, GeneSYS moved to dismiss the complaint on the ground that the Note was usurious. Adar Bays cross-moved for summary judgment. The United States District Court for the Southern District of New York (Carter, J. ) granted Adar Bays’ motion, holding that the Note's conversion option did not result in a criminally usurious interest rate.

The first issue presented is whether the Note violates New York's criminal usury law because it contains a conversion option with a 35% discount that, if treated as interest, raises the interest rate above the statutory maximum (25%). Adar Bays, on the other hand, contends that upon conversion, the transaction becomes an equity investment to which usury laws do not apply. The second issue presented is, if the interest rate does violate § 190.40, whether the Note is void ab initio , as it would be if New York's civil usury law, N. Y. Gen. Oblig. Law § 5-511, applied. If the Note is void, GeneSYS would be relieved of its obligation to repay the money it borrowed.

Because the resolution of both issues turns on questions of state law for which no controlling decisions of the New York Court of Appeals exist, we certify two questions to the Court of Appeals. See 22 N.Y.C.R.R. § 500.27(a) and 2d Cir. R. 27.2(a). Although the parties did not request certification, we may seek it nostra sponte and we do so here. Corsair Special Situations Fund, L.P. v. Pesiri , 863 F.3d 176, 182-83 (2d Cir. 2017).¹

BACKGROUND

GeneSYS is a publicly held corporation in New York that owns several companies which produce various types of medical supplies. Its shares are traded in the over-the-counter market. In May 2016, GeneSYS borrowed $35,000 from Adar Bays. The transaction was at arm's length and both parties were represented by counsel. The loan was documented by a Securities Purchase Agreement and Convertible Redeemable Note that obligated GeneSYS to repay any outstanding balance by May 2017. The Note contained a stated annual interest rate of 8% as well as significant prepayment penalties. The Note also provided that Adar Bays, at its sole discretion, was entitled, at any time after 180 days from the Note's issuance, to convert any or all of the outstanding balance into shares of GeneSYS common stock at a conversion price set at 65% of the lowest trading price of the common stock as reported on the National Quotations Bureau OTCQB exchange market for the twenty prior trading days. The Note also provided that GeneSYS was to instruct its transfer agent to hold in reserve stock amounting to three times the number of shares required if the Note were fully converted to facilitate any conversion by Adar Bays.

In May 2016, the Note was issued and GeneSYS directed Adar Bays to disburse $2,000 for its attorney's fees and to disburse the remaining $33,000 to GeneSYS. Adar Bays complied with those directions and the Note was fully funded. Six months later, in November 2016, Adar Bays submitted a notice to GeneSYS to convert $5,000 of the amount outstanding into common stock. GeneSYS acknowledged receipt of the notice but refused to honor it. In December 2016, Adar Bays sent GeneSYS a notice of default. To date, GeneSYS has not delivered any shares or repaid any of the outstanding principal or any interest.²

Adar Bays sued in February 2017, alleging, essentially, breach of contract. GeneSYS moved to dismiss the complaint pursuant to Fed. R. Civ. P. 12(c) on the ground that the Note was void as usurious, and Adar Bays moved for summary judgment on all claims. The district court granted summary judgment in favor of Adar Bays and denied GeneSYS's motion to dismiss. Though immaterial to the issues presented here, the district court also held that the liquidated penalties clause and daily penalties clause in the Note were invalid. This appeal followed.

DISCUSSION

I.

N.Y. Penal Law § 190.40 provides that a loan is criminally usurious when the parties knowingly provided for an interest rate of 25% or more. With exceptions not relevant here, a corporation may assert criminal usury as an affirmative defense to efforts to collect on a loan. N.Y. Gen. Oblig. Law § 5-521 ; see, e.g., Blue Wolf Capital Fund II, L.P. v. Am. Stevedoring, Inc. , 105 A.D.3d 178, 182, 961 N.Y.S.2d 86 (2013).

New York's civil usury laws operate somewhat differently. The civil usury statute prohibits loans at rates exceeding 16% per year. N.Y. Gen. Oblig. Law § 5-501. Corporations cannot assert a civil usury defense. N.Y. Gen. Oblig. Law § 5-5-521. Section 5-511 provides that all contracts "whereupon or whereby there shall be reserved or taken, or secured or agreed to be reserved or taken, any greater sum, or greater value, for the loan or forbearance of any money, goods, or other things in action, than is prescribed in section 5-501, shall be void." There is no parallel provision in the criminal usury law for voiding a loan found to be criminally usurious.

When a note is not usurious on its face, usury is not presumed and the debtor must prove all the elements of usury, including usurious intent. "[A] heavy burden rests upon the party seeking to impeach a transaction for usury." Gandy Mach. Inc. v. Pogue , 106 A.D.2d 684, 685, 483 N.Y.S.2d 744 (1984). Moreover, a debtor asserting a defense of usury must establish the elements of usury "by clear and convincing evidence." Blue Wolf Capital Fund II , 105 A.D.3d at 183, 961 N.Y.S.2d 86 (citing Giventer v. Arnow , 37 N.Y.2d 305, 372 N.Y.S.2d 63, 333 N.E.2d 366, 369 (1975) ). Finally, usury laws only apply to loans. If there is no loan, "there can be no usury, however unconscionable the contract may be." Seidel v. 18 E. 17th St. Owners, Inc. , 79 N.Y.2d 735, 586 N.Y.S.2d 240, 598 N.E.2d 7, 11-12 (1992).

GeneSYS principally argues that the 35% discount that applies if Adar Bays elects to convert any outstanding debt into stock violates § 190.40 because that discount rate is the Note's "real" interest rate. This is so, according to GeneSYS, because Adar Bays enjoyed a unilateral right to convert at that rate, which was fixed when the Note was issued and did not fluctuate with market conditions. Thus, for each $1.00 of principal that Adar Bays requests be converted into shares, GeneSYS is required to deliver stock worth $1.35.³ In other words, GeneSYS argues, a conversion option allowing Adar Bays to recover the balance as shares at a fixed 35% discount is interest, separate from the stated 8% rate that applies to cash repayments. More simply: the interest on a cash repayment is 8% per annum, and the "interest" on a ‘converted stock repayment’ is 35%, the latter, according to GeneSYS, rendering the note usurious under Section 190.40. GeneSYS also argues that the Court should read § 190.40 in para materia with § 5-511 and hold the Note void.

Adar Bays takes the position that the 35% discount is not interest because at the time of contracting, the point at which the usury determination is made, it would be entirely speculative whether Adar Bays would ever exercise its conversion option. Once that speculation is removed—if and when Adar Bays elects to convert some or all of the balance—that transaction becomes an equity investment, which is not subject to the usury laws.⁴ See, e.g., LG Capital Funding, LLC v. Sanomedics Int'l Holdings, Inc. , No. 508410/2014, 2015 WL 7429581, at *10 (N.Y. Sup. Ct. Nov. 23, 2015).

This is not the first case in our Circuit to present this issue; however, previous cases have not resolved it. See, e.g., Blue Citi LLC v. 5Barz Int'l Inc. , 802 Fed.Appx. 28 (2d Cir. 2020) ; LG Capital Funding, LLC v. On4 Communications, Inc. , 796 Fed.Appx. 57 (2d Cir. 2020). The New York courts to have considered this issue have generally rejected the view that a conversion option with a discounted rate should be treated as interest.⁵

In Sanomedics , for example, the court concluded that a convertible option did not make the note in question usurious:

[U]sury laws apply only to loans or forbearances, not investments. Although the initial transactions were loans, which were clearly not usurious ... the Securities Purchase Agreement provided that, upon conversion, [Defendant] was selling securities ... to [Plaintiff] as an "investor." ... While a loan may not be disguised as an investment as a cover for usury, ... upon conversion at [P]laintiff's election ... [Defendant's] debt to [P]laintiff [would] become an investment, upon which [P]laintiff took the risk that the stock could be completely worthless.

2015 WL 7429581 at *10. But the reasoning of other decisions of New York courts complicates this conclusion. In Blue Wolf Capital Fund II , for example, the Appellate Division wrote that "[t]o determine whether a transaction is usurious, courts look not to its form but to its substance or real character. If an instrument provides that the creditor will receive additional payment in the event of a contingency beyond the borrower's control, the...