A few months ago, the First Department appellate court invalidated a $1.13 million loan because it found its charges and interest to violate New York's criminal usury laws. The interesting facts of this case are worthy of discussion.
In 2009, ASI, a corporation, needed an immediate cash infusion. Blue Wolf, an investment firm, agreed to lend ASI a sum of money while it conducted due diligence and decided whether it would make an equity investment in ASI. The loan documents, executed in January 2010, provided for Blue Wolf to loan ASI $1,130,000 with interest to accrue at 12% per annum. The loan was secured by ASI's assets. Although not completely clear from the decision, it seems that Blue Wolf could call the loan upon demand. At closing, ASI received only $805,000 because Blue Wolf kept $325,000 as fees and deposits. Those were broken down as a $50,000 commitment fee, a $75,000 deposit against Blue Wolf's costs and expenses incurred in connection with the loan, and $200,000 was retained by Blue Wolf as a "'deposit against future commitment fees'" in the event that ASI rolled over the loan into future financing. Even with this fee charged, Blue Wolf was not obligated to advance future funds or even roll over the loaned funds into a new note. Remarkably, the loan terms provided that if new financing was not arranged by March 31, 2010, Blue Wolf was permitted to keep all or part of the $200,000 as "'compensation for [Blue Wolf's] time and expenses, as determined by [Blue Wolf] in its sole discretion.'"
Blue Wolf admitted that by January 2010, it had decided that it would not purchase any portion of ASI and would not provide further financing. Blue Wolf called the loan in March 2010, claiming a loss of confidence in ASI, and informed ASI that it would keep half of the $200,000 it retained. ASI did not repay the loan, and in May 2010, Blue Wolf again demanded repayment, and informed ASI that it would now keep the entire $200,000. When ASI did not pay, Blue Wolf began the foreclosure process against ASI's assets, as a secured lender. Because of a defect in the March notice, Blue Wolf notified ASI in July 2010 that it would accept ASI's assets in lieu of repayment of the loan. In July and August 2010, ASI paid Blue Wolf $54,000. Blue Wolf rejected those payments claiming that it had foreclosed on ASI's assets, which ASI was then holding for Blue Wolf's benefit. Blue Wolf offered to sell those assets back to ASI for $1.3 million and apply the $54,000 toward that purchase price.
When ASI refused to accede to Blue Wolf's demands, Blue Wolf filed a lawsuit. ASI responded by asking the judge to find the loan usurious and void, which request the judge granted. The court held that when the $325,000 Blue Wolf retained from the loan proceeds was added to the interest rate and applied against the amount ASI received, the effective interest rate was 57.14%, violating the 25% criminal usury cap. As a result, the loan was void and unenforceable.
Arguing among other things, that the $325,000 should not be deemed an interest payment, Blue Wolf appealed. Alternatively, Blue Wolf claimed that even if usurious, the interest rate should be modified to be brought within the legal limit, and then enforced. Not surprisingly, Blue Wolf found the appeals court remarkably unsympathetic.
Addressing just the $200,000 deposit against future commitment fees, the appeals court stated that courts are "not to look to its form [of the transaction] but to its substance or real character." Because this "fee" was for payment of a contingency beyond the borrower's control, the appellate court found that fee to be a masked interest charge, bringing the actual rate to 36.9%. With this, the appellate court affirmed the court's decision and voided the entire transaction.
This issue was common in the early days of the mortgage/foreclosure mess, even in commercial foreclosures. Lenders stacked many fees and charges onto the loan proceeds which when challenged, were deemed additional interest and void. While the outcomes of those cases were not as dramatic as found here, principally because the amounts charged were far lower, this case is instructive as to the pitfalls of carelessly and greedily adding loan fees on top of interest charges. This practice is often found where high rate loans are made to desperate borrowers. While not encouraging default and cautioning that these facts were extreme, one must be aware that despite a lender's aggressive approach upon nonpayment, a borrower has remedies of which it can avail itself. Feel free to contact us if you find yourself in this kind of unfortunate situation.