By Christopher Basile
I. Introduction
Choice-of-law provisions may bypass state statutes implemented to protect the general public and they may also reduce the effectiveness of the state’s legislative intent. A choice-of-law clause is a provision in a contract where the parties choose a state’s law to govern any conflicts or disputes that may arise between the parties.[1] Companies may implement choice-of-law clauses in their contracts to avoid statutes or regulations of various states.[2] Many companies use choice-of-law provisions to intentionally avoid New York laws and regulations. Companies attempt to avoid a series of criminal usury statutes in New York. Usury is defined as an illegal rate of interest that may be charged on a financial instrument.[3] In conclusion, many companies intentionally try to avoid New York’s criminal usury statutes through the use of choice-of-law provisions.
When a transaction has been executed in New York between two businesses, New York law should govern if the transaction is substantially related to New York.[4] Additionally, when a transaction has been executed between parties in New York, and fundamental public policy is being violated by enforcing a choice-of-law provision, New York law should govern the transaction.[5]
Part II will provide a brief history of usury in New York. Part III will analyze the various usury statutes of New York. This section will also discuss how businesses may invoke criminal usury as an affirmative defense, the required percentage threshold for criminal usury to be invoked in New York, and the various financial instruments that may be deemed as criminally usurious in New York. Part IV will delve into the intent of predatory businesses and explain why these businesses choose certain states to govern their contracts. Part V will discuss New York’s substantial relationship test and how it impacts choice-of-law provisions. Part VI will discuss New York’s fundamental public policy and how it supersedes choice-of-law provisions. Part VII will examine the ramifications of criminally usurious transactions and how these transactions are void in New York. Finally, Part VIII will conclude by summarizing the decisions of New York’s Court of Appeals and the Second Circuit and the impact that these decisions will have on a business that has entered into a transaction with a predatory company where a choice-of-law provision exists.
II. A Brief History of Usury in New York
Since its founding, the courts in New York have taken a strong position against enforcing payments with a rate of interest above what is permitted by law. Amidst establishing the foundation of interest limits on financial instruments, “the ‘Statute of Anne’ (1713)[6], which fixed a maximum rate of interest at five percent for all loans, was the model followed.”[7] In New York State, the leading case regarding criminally usurious transactions is Curtiss v. Teller,[8] in which the New York Court of Appeals held that usury statutes declare a usurious transaction void and provide for forfeitures and penalties against the usurer.[9] The decision and reasoning of the Curtiss Court was sustained nearly seventy years later in Szerdahelyi v. Harris.[10] The Court of Appeals in Szerdahelyi analyzed the history surrounding usury laws and noted that the interpretation of the usury statutes in Curtiss is consistent with New York’s legislative view on the matter.[11]
Further, the Court held that a usurious transaction is void ab initio (invalid from the outset), and a financial instrument with a total interest charge exceeding the statutory limit results in the lender being unable to recoup on the money that he or she has advanced.[12] Additionally, a total interest charge exceeding the statutory limit results in the lender being unable to collect the interest due on the transaction.[13] At the time Szerdahelyi was being heard, the New York State Legislature made further revisions to the usury laws due to the evolving complexity of financial crimes such as loan-sharking.[14] Loan-sharking has been described by the courts in New York as “one of the most heinous, virtually bloodsucking criminal activities of all times.”[15] The Legislature in New York subsequently enacted comprehensive legislation to deal with this problem.[16] The express intent of this legislation was to “amend the penal law and the general obligations law, in relation to criminal usury and possession of records of a criminally usurious loan.”[17] Usurious transactions are ultimately void under New York law, regardless of whether they violate the civil section of §5-501 or the criminal section under New York Penal Law § 190.40.[18]
III. New York Usury Statutes
New York has enacted multiple statutes addressing the State’s legislative view on the heinous nature of usury. According to New York Penal Law:
A person is guilty of criminal usury in the second degree when, not being authorized or permitted by law to do so, he 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 twenty-five per centum per annum or the equivalent rate for a longer or shorter period.[19]
Further, “criminal usury in the second degree is a class E felony.”[20] In the event of a criminally usurious interest rate under the sovereign of New York, the usurer is estopped from receiving interest on a loan.[21] In New York, corporations are prohibited from interposing the defense of civil usury to a contract.[22] In fact, only individuals may use civil usury as an affirmative defense to a contract.[23] Civil usury in New York exists when the total interest on a financial instrument exceeds a rate of sixteen percent per annum.[24] In New York, only individuals may use civil usury as an affirmative defense to a contract.[25] At first blush, it appears that companies may be barred from claiming criminal usury as an affirmative defense in New York. Nonetheless, while corporations cannot plead civil usury as a defense to a contract, corporations may plead criminal usury as an affirmative defense to a contract.[26] There is no legislative difference between what is called “civil” usury and “criminal” usury when it comes to New York’s General Obligation Law § 5-511.[27] However, usury is usury, and the Legislature saw fit to make two “levels” of usury in response to growing loan-sharking in the state, one that exceeds sixteen percent (civil), and the other that exceeds twenty-five percent (criminal).[28]
New York’s G.O.L § 5-501 caps the maximum amount upon which to assert a claim under §190.40 at $2,500,000.00.[29] The plain language of §190.40 as read with § 5-501, states that anything below $2,500,000.00 is subject to criminal usury and once found, the transaction is automatically voided.[30] Capping the maximum amount to $2,500,000.00 to make a financial instrument subject to the criminal usury statutes was intended to solve the usury problem in New York regarding substantial commercial loans, and is now a major part of the reason that multistate loan transactions are designated to be governed by New York law.[31] Ultimately, the financial instruments subject to the criminal usury statutes of New York include bonds, bills, notes (both demand and promissory), assurances, and conveyances.[32]
IV. Intent of Predatory Businesses
Usurious intent may be found by looking at the four corners of a financial instrument, and usurious intent may be found as a matter of law.[33] Intent is a critical element in a usury analysis.[34] Even if a lender of a financial instrument did not intend to violate the usury laws of New York, if the financial instrument in question charges an interest rate in excess of the statutory rate of twenty-five percent in New York, then it is immaterial whether or not the lender had actually intended to do so.[35] In a situation such as this, the intent is considered to be implied even though a lender had no actual intent to violate the usury laws.[36] New York courts have consistently ruled that when usury is determined to exist, the intent is implied.[37]
The court in In re Rosner[38] noted that when usurious intent is not found on the face of the financial instrument, usury becomes a disputed question of material fact.[39] Nonetheless, the conversion discount option, the share reserve requirement, and the default remedies expressly stated in the contract of the financial instrument set the total interest charge of the financial instrument in excess of twenty-five percent, and therefore, the intent to charge a usurious rate of interest was established.[40]
It is settled that a person coming to court with unclean hands is not afforded any equitable remedies.[41] When it comes to criminal usury, intent to charge a criminally usurious rate is implied based on the face of a financial instrument.[42] Regarding financial recovery for creditors or lenders surrounding a financial instrument, “the equitable maxim that he who comes into equity must come with clean hands.”[43] Furthermore, a New York court will deny equitable relief to a corporation when a corporation attempting to recover demonstrates egregious conduct, such as fraud, unconscionability, or bad faith.[44]
V. New York’s Substantial Relationship Approach and the Applicability of Choice-of-Law Provisions
If a contract between two parties is deemed to be usurious under the general usury statutes of all states to which it has a substantial relationship, then the forum will “apply the usury statute of that state that imposes the lightest penalty.”[45] The Supreme Court of the United States has ruled that in order to ensure that the choice-of-law is neither arbitrary nor fundamentally unfair, the choice-of-law must be from a state that has significant contacts with the parties and the occurrence or transaction in question.[46] Although New York recognizes that “the choice of law principle that parties to a contract have a right to choose the law to be applied in their contract, this freedom of choice on the part of the parties is not absolute.”[47]
New York courts generally enforce choice-of-law clauses.[48] The New York Court of Appeals addressed the substantial relationship approach and held that “while the parties’ choice of law is to be given heavy weight, the law of the state with the ‘most significant contacts’ is to be applied.”[49] In a contract between parties, New York law should apply, even if there is a choice-of-law provision electing another state to govern if significant contacts were in New York.[50] Moreover, when a state does not have a reasonable relationship to a contract between parties, and New York does have a reasonable relationship, then New York law should apply to the contract in question.[51] A reasonable relationship with New York may be established if the parties negotiate and execute a financial instrument in New York, the parties to a contract performed under the agreement in New York, and/or the principal place of business for either party has its principal place of business in New York.[52] In addition to the substantial relationship approach, New York “has a strong public policy against interest rates which exceed twenty-five percent.”[53]
VI. New York’s Fundamental Public Policy and Its Effect on Contract Provisions
New York has a strong fundamental public policy against interest rates from creditors that exceed twenty-five percent.[54] Moreover, New York has a heavy stance public policy against excessive interest rates, which must be enforced.[55] This essential public policy is further bolstered from the ruling in Clever Ideas, Inc. v. 999 Restaurant Corp,[56] in which the New York Superior Court held that the choice of Illinois law will not be given effect in part because New York’s usury prohibition is a fundamental public policy.[57]
Additionally, New York’s decision to criminalize interest rates exceeding twenty-five percent is further evidence that usury prohibition is a fundamental public policy.[58] The federal courts in the Second Circuit have recognized in its holdings that New York’s criminal usury laws represents an important and fundamental public policy that overrides a choice of law provision.[59] Even if the substantial relationship test with another state is satisfied, New York’s vital public policy reflected in its usury laws overrides the substantial relationship test, and New York law must apply.[60] Therefore, the substantive law of New York must be applied in a situation where a company brings a claim of criminal usury surrounding a financial instrument, even if there is a choice-of-law provision that states that another state’s law will govern the transaction in question between the company bringing the claim and the other party.
VII. The Effects of Criminally Usurious Financial Instruments in New York
The New York usury laws apply to financial instruments, such as loans and forbearances.[61] In order for a transaction to constitute a usurious loan, there must be two parties contracting (a debtor/borrower and a creditor/lender).[62] Additionally, it must appear that the real purpose of the transaction was, on the one side, to lend or provide money or a form of money at a usurious interest reserved in some form by the contract and, on the other side, to borrow upon the usurious terms dictated by the creditor/lender.[63]
In transactions involving criminally usurious financial instruments, “the effect of the exaction of an illegal rate of interest differs under the various provisions of the consolidated laws which deal with interest and usury.”[64] A criminally usurious financial instrument is null and void, and no equitable relief is granted to the creditor executing the usurious financial instrument under the sovereign of New York.[65] A criminally usurious instrument is treated as a pretense in New York and is ineffectual as a source of obligation or of right as a matter of law.[66] Further, in New York, not only is a criminally usurious transaction void, but a court also has the statutory power to declare any obligation or security taken by the lender in violation of the statute void as well, as a matter of law.[67] A 2017 New York Appellate Division case recognized the applicability of G.O.L. §5-511 as an affirmative defense of a criminally usurious transaction, voiding the underlying transaction.[68]
VIII. Conclusion
All in all, when a transaction has been executed in New York between two businesses, the transaction should be governed under New York law if the transaction is substantially related to New York. Additionally, when a transaction has been executed between parties in New York, and fundamental public policy is being violated by enforcing a choice-of-law provision, New York law should govern the transaction. If a company is unable to invoke criminal usury as an affirmative defense to an agreement due to a choice-of-law provision, the objective of protecting the public that New York attempts to achieve is frustrated and hindered. Further, a choice-of-law provision creates loopholes where a company can side-step the substantive statutes and regulations of a state, setting a dangerous precedent for the future.
[1] Glen Banks, 28 New York Practice Series: New York Contract Law § 8:3 (2019).
[2] William B. Emmal, comment, Evading Prohibitions on Usury Through Choice of Law, 9 Transactional Law. 6 (2009). Emmal stated, “[s]ome lenders might also use a choice-of-law clause to avoid the usury law of the state whose law would apply if no choice were made.” Id.
[3] 75 Am. Jur. 3d. Proof of Facts § 103 (2019).
[4] 19A N.Y. Jur. 2d. Conflict of Laws § 34 (2019). A choice-of-law provision will not be enforced or honored if the law chosen has no reasonable relationship or sufficient contacts with the transaction or subject matter of the contract in question. Id.
[5] Id. § 35 (2019). A choice-of-law provision will not be enforced or honored where to do so would violate a fundamental or public policy of the forum state.
[6] Public Act, 13 Anne., c. 15 (Gr. Brit. 1773). An act passed by Parliament to reduce the rate of interest on a loan without any prejudice to any Parliamentary Securities. Id.
[7] Franklin W. Ryan, Note, Usury and Usury Laws: A Juristic-Economic Study of the Effects of State Statutory Maximums for Loan Charges upon Lending Operations in the United States 181 (Boston & New York: Houghton Mifflin Company 1924).
[8] 217 N.Y. 649 (1916).
[9] Id. at 649.
[10] Szerdahelyi v. Harris, 67 N.Y.2d 42 (1986).
[11] Id. at 50.
[12] Id.
[13] Id.
[14] Id. at 50-51.
[15] Hammelburger v. Foursome Inn Corp., 76 A.D.2d 646, 650-51 (2d Dep’t 1981).
[16] Id.
[17] Szerdahelyi, 67 N.Y.2d at 51.
[18] See generally Bakhash v. Winston, 134 A.D.3d 468 (1st Dep’t 2015); Fareri v. Rain’s Int’l, Ltd 187 A.D.2d 481 (2d Dep’t 1992); Abir v. Malky, Inc., 59 A.D.3d 646 (2d Dep’t 2009); Russkaya Reklama, Inc. v. Milman, 47 Misc. 3d 88 (App. Term. 2d Dep’t 2d, 11th & 13th Dists. 2015) (holding in all these cases that the usurious transactions are void as a matter of law).
[19] N.Y. Penal Law § 190.40 (McKinney 2019).
[20] Id.
[21] N.Y. Gen. Oblig. law § 5-501(4) (McKinney 2019). “Interest shall not be charged, taken, or received on any loan or forbearance at a rate exceeding such rate of interest as may be authorized by law at the time the loan or forbearance is made.” Id.
[22] Id.
[23] Id.
[24] Id.
[25] Id. § 5-521(3). “(3) The provisions of subdivision one of this section shall not apply to any action in which a corporation interposes a defense of criminal usury as described in section 190.40 of the penal law.” Id.
[26] Id.
[27] Id. § 5-511.
[28] Id. § 5-501. On a note, the civil usury threshold is an interest rate in the excess of sixteen percent, whereas the criminal usury threshold on a note is an interest rate in the excess of twenty-five percent. Id.
[29] Id.
[30] Id.
[31] Joshua Stein, Confusory Unraveled: New York Lenders Face Usury Risks In Atypical Or Small Transactions, N.Y. St. B.J. 26, 27-28 (August 2001).
[32] Gen. Oblig. § 5-501.
[33] Blue Wolf Capital Fund II, L.P. v. Am. Stevedoring Inc., 105 A.D.3d 178, 184 (1st Dep’t 2013) (holding that if usury can be gleaned from the face of an instrument, intent will be implied, and usury will be found as a matter of law).
[34] N.Y. Banking Law § 380-E (McKinney 2019).
[35] Fareri v. Rain’s Int’l, Ltd 187 A.D.2d 481, 483 (2d Dep’t 1992). (holding that a transaction and supporting documents were void as a matter of law because as stipulated by the parties, the agreement was usurious on its face, and therefore, usurious intent can be applied).
[36] Id.
[37] See generally Venables v. Sagona, 85 A.D.3d 904 (2d Dep’t 2011); Abir v. Malky, Inc., 59 A.D.3d 646 (2d Dep’t 2009) (noting that all usurious agreements will be void and unenforceable as a matter of law).
[38] 48 B.R. 538 (Bankr. E.D.N.Y. 1985).
[39] Id. at 548.
[40] Id.
[41] Blue Wolf Capital Fund II, L.P. v. Am. Stevedoring Inc., 105 A.D.3d 178, 185 (1st Dep’t 2013). (holding that companies found to be charging criminally usurious rates of interest on a financial instrument are not entitled to equitable relief).
[42] Id.
[43] Lia v. Saporito, 909 F. Supp. 2d 149, 173 (E.D.N.Y. 2012) (holding that a party seeking equitable relief must not have unclean hands).
[44] Balaber-Strauss v. Murphy, 331 B.R. 107, 135 (Bankr. S.D.N.Y. 2005) (holding that equitable relief may be denied where a party applying for such relief is guilty of conduct involving fraud, unconscionability, or bad faith related to the matter at issue).
[45] 72 N.Y. Jur. 2d Interest and Usury § 57 (2019).
[46] Allstate Ins. Co. v. Hague, 449 U.S. 302, 308-09 (1981) (holding that applying a choice of law from a state with a mere slight and casual relationship to the parties and transaction would be fundamentally unfair to a state with a greater relationship to the parties or the transaction in question).
[47] S. Leo Harmony, Inc. v. Blinks Mfg. Co., 597 F. Supp. 1014, 1025 (S.D.N.Y. 1984).
[48] Banks, supra note 1. “In the absence of fraud or violation of a fundamental state policy, New York courts generally defer to the choice-of-law made by the parties in their contract. Choice-of-law provisions are generally honored because the parties are free to reach an agreement on whatever terms they prefer.” Id.
[49] Cargill, Inc. v. Charles Kowsky Resources, Inc., 949 F.2d 51, 55 (2d Cir. 1991) (ruling that New York law permits a court to disregard the parties’ choice-of-law provision in a contract when the most significant contacts surrounding the dispute in question are in another state).
[50] AM. Equities Grp., Inc. v. Ahava Dairy Prods. Corp., 2004 WL 870260, at *1, *8 (S.D.N.Y. Apr. 2004) (holding that because significant contacts were in New York, that New York law should apply, despite the agreement that New Jersey law would govern).
[51] Power Up Lending Grp., Ltd. v. Cardinal Energy Grp., Inc., 2:16-cv-1545 (DRH)(GRB), 2019 WL 1473090, at *1, *4 (E.D.N.Y. Apr. 3, 2019).
[52] Id.
[53] In re McCorhill Pub., Inc., 86 B.R. 783, 793 (Bankr. S.D.N.Y. 1988).
[54] AM. Equities Grp., 2004 WL 870260, at *8.
[55] American Exp. Travel Related Serv.’s Co., Inc. v. Assih, 26 Misc.3d 1016 (N.Y. City Civ. Ct. 2009).
[56] Clever Ideas, Inc. v. 999 Rest. Corp., No. 0602302/06, 2007 N.Y. Misc. LEXIS 9248, at *1, *2–4 (Sup. Ct. N.Y. Cty. Oct. 12, 2007).
[57] Id.
[58] Electric & Magneto Serv. Co. v. AMBAC Int’l Corp., 941 F.2d 660, 663 (8th Cir. 1991) (holding that the existence of a criminal provision is significant because the legislature would not allow a criminal law to be bypassed by the mere existence of a choice-of-law provision contained in a contract).
[59] Madden v. Midland Funding, LLC., 237 F. Supp. 3d 130, 145 (S.D.N.Y. 2017) (holding that New York’s interest in preventing criminal usury prevails over the choice-of-law provisions set forth by parties in a contract).
[60] Id.
[61] See generally Orvis v. Curtiss, 157 N.Y. 657 (1899); Bristol Inv. Fund, Inc. v. Carnegie Intern. Corp., 310 F. Supp. 2d 556, 562 (S.D.N.Y. 2003) (holding that the defense of usury must be found upon a loan or forbearance of money).
[62] Donatelli v. Siskind, 170 A.D.2d 433 (2d Dep’t 1991).
[63] Id.
[64] 72 N.Y. Jur. 2d Interest and Usury § 143 (2019).
[65] Id.
[66] Id.
[67] Id.
[68] Roopchand v. Mohammed, 154 A.D.3d 986 (2d Dep’t 2017) (holding that the defendants successfully met the burden of proving criminal usury and granted defendants’ cross motion for summary judgment, dismissing the action).
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