While health and safety concerns raised by the novel coronavirus are obvious and tragic, how long the economic impact will last is still largely unknown. For individuals and businesses in New York with outstanding loans that are facing financial hardship and the inability to make monthly payments, and for lenders bracing for a potential wave of defaults, New York's usury statutes may become fertile ground for litigation. Navigating the "complex and cross-referencing statutes that compose New York's usury law" and the state and federal decisions applying those statutes often necessitates cognitive gymnastics, with statutory text overridden by policy considerations. In re Venture Mortg. Fund, L.P., 282 F.3d 185, 189 (2d Cir. 2002). The lack of clear direction from New York's highest court has led to a patchwork maze of inconsistent decisions and unresolved questions. In this article, we attempt to make sense of New York's usury laws and shed light on the ambiguities and tensions that may leave some litigants and judges scratching their heads.

The Basics of New York Usury Law

Usury is an affirmative defense against loan enforcement, and "a heavy burden rests upon the party seeking to impeach a transaction for usury." Am. E Grp v. Livewire Ergogenics, 2020 WL 469312, at *7 (S.D.N.Y., Jan. 28). New York's civil and criminal usury provisions apply to loans differently (if at all) based on three main factors: the interest rate, the nature of the party asserting the defense and the initial amount of the loan.

The civil usury statute, General Obligations Law §5-501, bars interest above the level set in §14A of the Banking Law, currently 16% annually. Importantly, civil usury applies only to loans below $250,000 (with the exception of residential mortgage loans), and the defense is unavailable to corporations and limited liability corporations (LLCs). N.Y. Gen. Oblig. Law §5-521.

In contrast, criminal usury can be raised as a defense by natural persons and corporate entities alike, including LLCs. The criminal usury statutes, found in New York Penal Law §§190.40 and 190.42, forbid interest in excess of 25% annually and apply to loans up to $2.5 million. Loans above that amount are unaffected by New York's usury laws. And perhaps the most dramatic distinction between civil and criminal usury laws in New York is that loans that violate the civil usury laws are void in their entirety under General Obligations Law §5-511, while no specific provision voids loans that violate the criminal usury laws.

To successfully invoke usury as an affirmative defense, a defendant must establish the lender's usurious intent, which may be shown where "the lender intends to take and receive a rate of interest in excess of that allowed by law even though the lender has no specific intent to violate the usury laws." Livewire, 2020 WL 469312, at *7. To determine usurious intent, courts may look beyond the stated rate of interest and "consider the substance of the transaction"—for example, the use of origination fees to mask the true rate of interest. Id.

Unsettled Questions

Despite a wealth of case law concerning New York's usury laws, many issues remain unsettled, leading at times to an inconsistent application of the usury laws.

One question that courts and litigants grapple with is whether late fees and default rates of interest should be included in calculations to determine whether a loan is usurious. The New York Court of Appeals has not directly addressed the issue for well over a century. See Attorney Gen. v. N. Am. Life Ins. Co., 82 N.Y. 172, 191 (1880) ("An agreement to pay more than interest, by way of penalty for not paying the debt, is not usurious, because the debtor may relieve himself by paying the debt with lawful interest."). And while the majority of cases hold that New York's civil usury laws do not apply to "defaulted obligations" such as late fees and default interest, see, e.g., LG Capital Funding v. One World Holding, 2018 WL 3135848, at *11 (E.D.N.Y. June 27, 2018) (collecting cases); Kraus v. Mendelsohn, 948 N.Y.S.2d 119, 120 (2d Dept. 2012), some cases hold that criminal usury laws do apply in such instances. See Madden v. Midland Funding, 237 F. Supp. 3d 130, 140-46 (S.D.N.Y. 2017).

A second unresolved question is whether violation of the criminal usury laws allows a court to void a loan in its entirety. New York law expressly provides that violation of the civil usury laws (applying to loans up to $250,000) voids the entire loan, meaning a debtor is relieved of paying not only interest but outstanding principal as well. G.O.L. §5-511; see also In re Venture Mortg. Fund, L.P., 282 F.3d at 189 (in dictum). However, "there is no specific statutory authority for voiding a loan that violates the criminal usury statute only." EMA Fin. v. AIM Expl., 2019 WL 689237, at *7 (S.D.N.Y. Feb. 19, 2019). As the Second Circuit noted in In re Venture Mortgage Fund, the lack of a comparable provision voiding loans in excess of $250,000 presumably arises because "the larger the loan transaction, the less likely it is that the borrower needs or deserves financial protection." 282 F.3d at 189 (in dictum). As the New York Court of Appeals has noted, statutes prohibiting usurious loans are intended "to protect desperately poor people from the consequences of their own desperation." Schneider v. Phelps, 41 N.Y.2d 238, 243 (1977).

Nonetheless, some courts deem criminally usurious notes void ab initio—often with little stated rationale. See, e.g., Union Cap. v. Vape Holdings, 2017 WL 1406278, at *4 (S.D.N.Y. March 31, 2017) ("Under New York law, a contract is criminally usurious, and thus void, when the parties knowingly provided for an interest rate of 25% or more."); Kingsize Ent. v. Martino, 63 N.Y.S.3d 714, 715 (2d Dept. 2017) ("[A] loan that is criminally usurious is void."); Blue Wolf Cap. Fund II, LP v. Am. Stevedoring, 961 N.Y.S.2d 86, 90 (1st Dept. 2013) (same). Still other courts hold that the appropriate remedy for a note that is criminally usurious is to reduce the rate of interest to a nonusurious rate. See, e.g., Livewire, 2020 WL 469312, at *9 & n.15 (collecting cases).

The question of reforming usurious notes becomes even more pressing when the note contains a usury-savings clause. Such provisions purport to automatically reduce effective interest rates below usury maximums and apply sums in excess of those lawfully collected in order to reduce the principal. Twenty years ago, the Second Circuit observed that whether courts should give effect to usury-avoidance provisions was a "knotty and undecided question[] of New York law." Fed. Home Loan Mortg. v. 333 Neptune Ave., Ltd. P'Ship, 201 F.3d 431, 1999 WL 1295933 at *3 (2d Cir. 1999). The New York Court of Appeals still has not decided whether such provisions are effective. But the First and Second departments hold that language "purporting to reduce the interest rate to the legal rate in the event of a finding of usury, do not make the subject agreements nonusurious." Simsbury Fund v. New St. Louis Assoc., 611 N.Y.S.2d 557, 558 (1st Dept. 1994); Fred Shutzman Co. v. Park Slope Adv. Med., 9 N.Y.S.3d 682, 683 (2d Dept. 2015) (citing Simsbury).

In the absence of clear pronouncements from the New York Court of Appeals, some courts have engaged in cognitive gymnastics to reconcile the resulting tensions. For instance, in Livewire, the court found a $30,000 loan at an interest rate of 20% to be both civilly and criminally usurious because the borrower also agreed to issue to the lender stock worth $50,000 as "additional consideration," thus increasing the effective interest rate to above 25%. Livewire, 2020 WL 469312, at *7. Rather than reach the question of whether to void the loan because it violated the criminal usury statute, the court deemed the loan civilly usurious and thus unenforceable. Id. at *10. This even though under G.O.L. §5-521 a corporate defendant/borrower is prohibited from asserting civil usury as an affirmative defense. Nevertheless, the court held the loan to be void, reasoning that "[t]he statute does not state that the civil usury laws do not apply to contracts entered into by such an entity." Livewire, 2020 WL 469312, at *10.

Conclusion

The decision in Livewire is a cautionary tale for lenders. Likewise, unsettled issues—including whether default rates of interest should be included to determine usurious interest rates, whether loans bearing a criminally usurious rate of interest are void ab initio and whether usury-saving provisions may be enforced—allow courts to fashion remedies as a declaration of public policy and a creation of their own rough justice. In these times of economic turmoil, some courts might seek to tamp down overzealous collection efforts. Lenders and borrowers should take care to review their loan provisions carefully and to exercise caution when stepping into the litigation ring.

Daniel J. Buzzetta is a partner and Nicholas M. Rose is an associate at BakerHostetler.