Most laws in our country don't tend to differ much between states. In fact, it's probably accurate to say that a majority of states' substantive laws don't differ much at all even though sometimes it may not seem that way because of what the media tends to highlight. On the other hand, there are a few circumstances where states stand on opposite sides of the spectrum on a particular issue. It's important to note that these principles come from federalism and the bifurcated government that it promotes; a strong centralized government that allows individual territories with a certain level of autonomy.1 Simply, certain people in certain places care about certain things while others might not.
We often encounter one of those few circumstances where states are on separate sides of the spectrum with respect to usury laws. There are some states, like Texas, that have extremely harsh penalties2 and offer substantial rights to those who have been victimized by high interest lending. To the contrary, there are several states, like Delaware, that have no usury limitations whatsoever.3 Since our success in the landmark decision Adar Bays, LLC v. GeneSYS ID, Inc., 37 N.Y.3d 320 (2021), which decided that the value of a conversion discount within a convertible promissory note must be considered when engaging in a usury analysis, we've noticed some interesting activity to say the least.
Some toxic convertible note lenders have been inconspicuously approaching CEO's and quietly suggesting they make an amendment to any New York choice of law provisions within their transaction documents in exchange for little to no consideration. Unsurprisingly, the lender will then suggest that they choose a different state, such as Delaware for example, that doesn't have usury limitations. Unbeknown to the CEO, he or she may simply see it as a formality, notice that the material terms of the agreement are not being altered, the terms are relatively short and easy to understand, and therefore simply agree to the amendment. With all of the things a CEO is responsible for on any given day, a proposal such as this one can very easily be overlooked and seem less important than other things going on within the company, such as a deadline to file a form 10-K or 10-Q.
Fortunately, if a CEO were to agree to this, while the battle may be uphill, they still have an opportunity to take action and be successful. Under New York law, usurious agreements are void ab initio which directly translates to “from the beginning”. Thus, a usurious agreement is deemed void from the start, meaning that it is treated as if it never existed in the first place. You cannot amend something that does not exist. While a company would still be able to litigate the issue and assert its rights, it would be a bit more costly as this litigation is highly contested and many lenders are not hesitant to put up a fight. This is where many OTC companies lose; they end up waiting so long that their capital is nearly dried up and it makes it very difficult to put up a good fight against a schoolyard bully.
The best way to avoid this additional obstacle when engaging in litigation against a toxic convertible note lender is to consult with counsel prior to signing ANY document with one. This could be a critical decision that saves a company. This would leave the company with additional cash necessary to assert claims that could actually provide the company with a reward at the end of the litigation, such as dealer registration violations or RICO.
The moral of the story is that sometimes things that may seem to not be a big deal may actually end up being pretty significant. It's important for CEOs, especially ones dealing with entities as sketchy as these toxic lenders, to be very careful in all dealings and they can do that by engaging effective counsel from the beginning. While our firm's main focus is on litigation, we also offer general counsel and advisory services as we've slowly made headway as nationally recognized experts in our industry. Engaging us as general counsel prior to litigation can potentially save a company hundreds of thousands of dollars in litigation costs alone. Additionally, our services could provide a number of other benefits to a company considering our firm has decades of experience dealing with OTC companies in every respect beginning with a company's inception, through several rounds of funding and organic growth.
Footnotes
1 While federal laws evidently apply to all citizens and states in this country, each state also has its own legislation and common law developed through time which evidences a state's fundamental policy interests and considerations. This is because of the 10th Amendment; most public policy objectives are left for states to decide.
2 Texas Usury laws could provide up to three times the excess interest charged pursuant to a loan. See https://prevaillawyers.com/the-texas-usury-trap/.
3 Here is a comprehensive tool that allows you to determine a state's usury policy: https://www.csbs.org/50-state-survey-consumer-finance-laws.
Originally Published 29 March 2022
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.