Adar Bays, LLC v. GeneSYS ID, Inc.

• Decision Date: 14 October 2021
• Docket Number: 51
• Citation: 37 N.Y.3d 320,179 N.E.3d 612,157 N.Y.S.3d 800
• Parties: ADAR BAYS, LLC, Respondent, v. GENESYS ID, INC., Formerly Known as RX Safes, Inc., Appellant.
• Court: New York Court of Appeals Court of Appeals

37 N.Y.3d 320

179 N.E.3d 612

157 N.Y.S.3d 800

ADAR BAYS, LLC, Respondent,

v.GENESYS ID, INC., Formerly Known as RX Safes, Inc., Appellant.

No. 51

Court of Appeals of New York.

October 14, 2021

The Basile Law Firm P.C., Jericho (Marjorie M. Santelli and Mark R. Basile of counsel), and Phillipson & Uretsky, LLP, New York City (Jonathan Uretsky of counsel), for appellant.

Garson, Segal, Steinmetz, Fladgate LLP, New York City (Kevin Kehrli, Michael M. Steinmetz and Maddie Brown of counsel), for respondent.

Naidich Wurman, LLP, Great Neck (Richard S. Naidich, Bernard S. Feldman and Robert P. Johnson of counsel), for Power Up Lending Group, Ltd., amicus curiae.

OPINION OF THE COURT

WILSON, J.

The United States Court of Appeals for the Second Circuit has certified two questions to our Court:

‘‘1. 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.

2. If the interest charged on a loan is determined to be criminally usurious under N.Y. Penal Law § 190.40, whether the contract is void ab initio pursuant to N.Y. Gen. Oblig. Law § 5–511. " ( 962 F.3d 86, 94 [2d Cir 2020].)

We answer both questions in the affirmative.

GeneSYS ID, Inc. ("GeneSYS") is a publicly held corporation that produces various types of medical supplies. Adar Bays, LLC is a limited liability company based in Florida. On May 24, 2016, Adar Bays loaned GeneSYS $35,000. In exchange, GeneSYS gave Adar Bays a note with eight percent interest that would mature in one year. The note included an option for Adar Bays to convert some or all of the debt into shares of GeneSYS stock at a discount of 35% from the lowest trading price for GeneSYS stock over the 20 days prior to the date on which Adar Bays requested a conversion. Adar Bays could exercise its option starting 180 days after the note was issued and could do so all at once or in separate partial conversions.

The note included additional provisions favorable to Adar Bays. Although GeneSYS could prepay the note within the first 180 days, prepayment would incur significant penalties exceeding 100% of the face of the note and, after Adar Bays’ conversion right ripened, prepayment was prohibited. If GeneSYS went bankrupt or failed to maintain current filings with the U.S. Securities and Exchange Commission ("SEC"), the interest rate would increase to "24 percent per annum or, if such a rate is usurious ... then at the highest rate of interest permitted by law." The note further provided for events that would automatically result in an increase in the principal owed. For example, if GeneSYS were delisted from any stock exchange, the principal would increase by 50% and if Adar Bays lost its bid price in a stock market, the principal would increase by 20%.

Six months and four days after the note was issued, on November 28, 2016, Adar Bays requested conversion of $5,000 of debt into 439,560 shares of stock. GeneSYS refused—cancelling its transfer agent and seeking to renegotiate the loan. On November 28, GeneSYS was trading for $0.024 per share,¹ the conversion price was $0.011. Adar Bays then sued GeneSYS in the United States Southern District of New York for breach of contract. GeneSYS filed a motion to dismiss arguing the contract was void because the loan's rate of interest, including both the stated interest and conversion option, exceeded the criminal usury rate of 25%. Adar Bays opposed GeneSYS's dismissal motion and filed its own motion for summary judgment.

The federal district court held largely in Adar Bays’ favor, rejecting the argument that the value of the conversion option should be added to the note's stated interest rate because it "was simply too uncertain at the time of contracting" ( 341 F Supp 3d 339, 356 [S.D.N.Y.2018] ). Of particular concern to the district court was the possibility that GeneSYS " ‘could become delinquent in its filings, become delisted, experience sudden decreases in its stock price, experience no demand for its stock, or simply cancel the reserve or refuse a conversion’ " ( id., quoting Adar Bays, LLC v. Aim Exploration, Inc., 285 F Supp 3d 698, 702–703 [S.D.N.Y.2018] ). The court then awarded Adar Bays $92,308 in expectation damages based on the number of shares Adar Bays would have received had it converted the entirety of the note on the day of the breach, valuing each share at $0.03.

On appeal, the Second Circuit observed that, for a varied set of reasons, most federal district courts had concluded that similar conversion options did not constitute interest under New York's usury laws ( 962 F.3d 86, 91 [2d Cir. 2020] ). Nonetheless, the Second Circuit recognized that some New York courts, in other contexts, had added the value of future, contingent payments to a note's stated interest rate when evaluating a usury defense ( id., citing Blue Wolf Capital Fund II, L.P. v American Stevedoring Inc., 105 A.D.3d 178, 182, 961 N.Y.S.2d 86 [1st Dept. 2013] ). The Second Circuit also discerned ambiguity as to whether a loan made to a corporation, even if determined to exceed the criminal usury rate by a court, was void or subject to reformation in the exercise of equitable jurisdiction (id. at 92, citing Blue Wolf, 105 A.D.3d at 183, 961 N.Y.S.2d 86 and In re Venture Mtge. Fund, L.P., 282 F.3d 185, 189 [2d Cir. 2002] ). As a result, the Second Circuit certified two questions to us. Pursuant to section 500.27 of this Court's Rules of Practice, we accepted these certified questions ( 35 N.Y.3d 996, 125 N.Y.S.3d 671, 149 N.E.3d 432 [2020] ), and now answer them in the affirmative.

Certified Question No. 2: Whether Criminally Usurious Contracts are Void Ab Initio

We begin with the Second Circuit's second question because the background of New York usury law helps to frame both questions. The text, history, and purpose of New York's usury laws demonstrate that, if the borrower establishes the defense of usury in a civil action, the usurious loan transaction is deemed void and unenforceable, resulting in the uncollectability of both principal and interest. We now clarify that this same result obtains when the 25% interest rate cap set forth in Penal Law § 190.40 —incorporated by reference in General Obligations Law § 5–521(3) —applies to a loan to a corporation and the interest charged on the loan exceeds that cap.

New York usury law is composed of General Obligations Law §§ 5–501, 5–511, 5–521 ; Banking Law § 14–a (1) ; and Penal Law § 190.40. Together, the statutes establish that loans of less than $250,000 to individuals cannot exceed a 16% annual rate, loans between $250,000 and $2.5 million cannot exceed 25% (the criminal usury rate) and loans of $2.5 million or more are not subject to the usury laws. More specifically, the General Obligations Law and Banking Law provide that the maximum rate of interest upon a "loan or forbearance of any money, goods, or things" shall be 16% per annum unless otherwise provided by law ( General Obligations Law § 5–501[1] ; see Banking Law § 14–a [1] ), and "[n]o person or corporation shall, directly or indirectly, charge take or receive any money, goods, or things in action as interest" at a rate exceeding 16% ( General Obligations Law § 5–501[2] ). In addition, a lender commits a class E felony when, without other legal authorization, the lender, "knowingly charges, takes or receives any money or other property as interest on the loan or forbearance of any money or other property, at a rate exceeding [25%] per annum or the equivalent rate for a longer or shorter period" ( Penal Law § 190.40 ). Any loan that reserves or takes any greater interest "than is prescribed in section 5–501"—the civil usury prohibition (16%)—"shall be void" (unless the lender is a bank or loan association, which will be held to have forfeited all interest on the loan) ( General Obligations Law § 5–511[1] ). Under General Obligations Law § 5–521(1), the defense of usury is not available to corporations, but this bar does not preclude a corporate borrower from raising the defense of "criminal usury" (i.e., interest over 25%) in a civil action (see id. § 5–521[3] ), as occurred here.²

A.

To understand New York's current usury laws, it is important to examine their history. New York's prohibitions on usury extend back to at least 1717, when the colony adopted an act defining usury as interest charged above six per cent per year on a loan (1 Colonial Laws of N.Y. at 909). The legislature amended the law over the years to adjust the interest rate (1 Colonial Laws of N.Y. at 1004; 2 Colonial Laws of N.Y. at 980). Any excess interest rendered the loan agreement "utterly void" (1 Colonial Laws of N.Y. at 909). If found to be usurious, the lender forfeited not just principal and interest, but three times the value of the interest ( Curtiss v. Teller, 157 App.Div. 804, 810, 143 N.Y.S. 188 [4th Dept. 1913], affd 217 N.Y. 649, 112 N.E. 1056 [1916] ; 1 Colonial Laws of N.Y. at 910).

In 1787 the new state of New York replaced the prior law (L 1787, ch 13). It imposed a seven percent cap and required the complete voiding of the transaction but eliminated the treble damage provision (id. [retaining language pronouncing "all deposites [sic ] of goods or other things whatsoever for payment of any principal or money to be lent" in usurious contracts "utterly void"]). In addition, the statute exempted holders of negotiable instruments who had purchased the instrument in good faith without knowledge that the original note was usurious (id. ).

The statute's strict forfeiture provision engendered conflict. The courts of equity took issue with the forfeiture of principal on moral grounds and began requiring borrowers to "repay or offer to repay the sum, together with interest, in order to obtain relief" ( Curtiss, 157 App.Div. at 810, 143 N.Y.S. 188 ).³...