ADAR BAYS, LLC v. GENESYS ID, INC. FKA RX SALES, INC.
No. 18-3023
United States Court of Appeals For the Second Circuit
June 11, 2020
August Tеrm 2019 (Submitted: February 26, 2020 Questions Certified: June 11, 2020)
PARKER, LIVINGSTON, NARDINI, Circuit Judges.
Appeal from an order of the United States District Court for the Southern District of New York (Carter, J.), granting summary judgment in favor of Adar Bays, LLC, the holder of a Convertible Redeemable Note securing a loan to GeneSYS ID, Inc. The loan was in default and the Defendant made an affirmative defense of usury. The district court held that the Note‘s interest rate did not violate the New York State criminal usury law,
KEVIN KEHRLI, Garson, Segal, Steinmetz, Fladgate LLP, New York, NY,
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 connectiоn 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,
In the court below, GeneSYS moved to dismiss the сomplaint 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, rаises 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
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
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 exchangе market for the twenty prior trading days. The Note also provided that GeneSYS was to instruct its transfer agent to
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
DISCUSSION
I.
New York‘s civil usury laws operate somewhat differently. The civil usury statute prohibits loans at rаtes exceeding 16% per year.
“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 (N.Y. 3d Dep‘t 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 (citing Giventer v. Arnow, 333 N.E.2d 366, 369 (N.Y. 1975)). Finally, usury laws only apply to loans. If there is no loan, “there can be no usury, however uncоnscionable the contract may be.” Seidel v. 18 E. 17th St. Owners, Inc., 598 N.E.2d 7, 11-12 (N.Y. 1992).
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 exerсise 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., No. 18-cv-3044, 2020 WL 1043452 (2d Cir. Mar. 4, 2020); LG Capital Funding, LLC v. On4 Communications, Inc., No. 18-3019, 2020 WL 1074501 (2d Cir. Mar. 6, 2020). The New York courts to have considered this issue have gеnerally rejected the view that a conversion option with a discounted rate should be treated as interest.5
[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 prоvided 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 contingent payment constitutes interest within the meaning of the usury statutes.” 105 A.D.3d at 183.
The district courts оf this Circuit have generally concluded that a conversion option at a discounted rate does not violate usury laws.6 In Blue Citi LLC v. 5Barz International Inc., for example, the district court noted that usury laws apply only to loans, not to equity investments. 338 F.Supp.3d at 335. “Once a loan‘s principal is converted to shares, the transaction takes on the character of an equity investment. . . .” Id. In Union Capital, LLC v. Vape Holdings Inc., the district court wrote:
[Defendant] argues that, in considering the effective interest rаte, the Court should also include the potential profit [Plaintiff] might reap by converting shares at a 42% discount. The Court disagrees. [Plaintiff] simply held an option to convert shares, and
it could have elected to obtain repayment in cash, which would clearly not have been usurious. Moreover, even if [Plaintiff] chose to convert the loan principal into shares, any potential profit [Plaintiff] might realizе would still be dependent on the market price at the time of conversion and so, therefore, would be too uncertain to incorporate into an interest rate calculation. Furthermore, even if the discount rate could be considered[,] a usury defense could no longer be applied against the loan once the Note principal was converted into equity in [Defendant].
2017 WL 1406278 at *5.7 Despite the number of cases from New York state and
Accordingly, wе certify the following question to the Court of Appeals: 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
II.
Civil usury is governed by
Criminal usury, on the other hand, is governed by
knowingly charges, takes or receives any money or other propеrty . . . at a rate exceeding twenty-five per centum per annum.” Unlike
District courts in this Circuit have noted that “[i]t is an open question under New York law whether a criminally usurious loan is void ab initio or whether a successful defense based on criminal usury results merely in the cancellation of the interest obligation or in a revised obligation to pay а non-usurious rate.” Adar Bays, LLC v. 5Barz Int‘l, Inc., 2018 WL 3962831, at *4; see also Union Capital, 2017 WL 1406278, at *8; Blue Wolf Capital Fund II, 105 A.D.3d at 182.
GeneSYS, relying on
There is no authoritative guidance on this issue from the Court of Appeals and the existing case law is unclear.9 The
shares or repay any of the outstanding debt. Should the Note now be declared void, GeneSYS will walk away with the entirety of the loan—achieving what could be viewed as a “total windfall” at the expense of Adar Bays.
Given these considerations and the lack of statutory authority or precedent from the New York Court of Appeals, we certify the following question to the Court of Appeals: If thе interest charged on a loan is determined to be criminally usurious under
CERTIFICATION
Pursuant to the rules of the New York Court of Appeals, “[w]henever it appears to . . . any United States Court of Appeals . . . that determinative questions of New York law are involved in a case pending before that court for which no controlling precedent of the Court of Appeals exists, the court may certify the dispositive questions of law to the Court of Appeals.”
Our decision to certify questions to the Court of Appeals is discretionary, and when exercising that discretion we consider whether: (1) “the New York Court of Appeals has not squarely addressеd an issue and other decisions by New York courts are insufficient to predict how the Court of Appeals would resolve it“; (2) “the statute‘s plain language does not indicate the answer“; (3) “a decision on the merits requires value judgments and important public policy choices that the New York Court of Appeals is better situated than we to make“; and (4) “the questions certified will control the outcome of the case.” See Penguin Grp. (USA) Inc. v. Am. Buddha, 609 F.3d 30, 42 (2d Cir. 2010). Each of these factors weighs in favor of certification in this case.
The New York Court of Appeals has not addressed either question certified here, and similar questions have not “been litigated in New York courts often enough that sufficient precedents exist for us to make a determination concerning their proper outcome.” Commodity Futures Trading Comm‘n v. Walsh, 618 F.3d 218, 231 (2d Cir. 2010). Neither of the questions is resolved by the text of the relevant statutes. Both questions turn on policy determinations that the Court of Appeals is best suited to make, including the balance of interests of short-term lenders and high-risk debtors. The answers to these questions will have important ramifications for New York‘s financial community. Finally, the questions certified will control the outcome of the case. See Penguin Grp. (USA) Inc., 609 F.3d at 42. Because these factors weigh in favor of certification, we certify the questions formulated above and restated below.
CONCLUSION
We hereby certify the following questions to the New York Court of Appeals:
- 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. - 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 toN.Y. Gen. Oblig. Law § 5-511 .
We invite the Court of Appeals to reformulate these questions as it sees fit or expand them to address any other issues of New York law that would assist this Court in determining whether discounted conversion rates are interest pursuant to
It is hereby ORDERED that the Clerk of this Court transmit to the Clerk of the New York Court of Appeals this opinion as our certificate, together with a complete set of briefs, appendices, and the record filed in this case by the parties. This panel retains jurisdiction for purposes of resolving this appeal once the New York Court of Appeals has responded to our certification.
CERTIFICATE
The foregoing is hereby certified to the New York Court of Appeals pursuant to