August 2, 2018

Choice of Law: Don’t Choose Your Way Into a Usury Claim

This recent blog from Weil’s Glenn West is a reminder that asking for a pound of flesh in a commercial transaction can still buy you a lot of trouble – particularly if you choose the wrong state’s law to govern your deal.  Usury laws are alive & well in many states, and this excerpt says that they’re extremely complicated to boot:

But it is important to note that it is not just the stated rate that can count as interest, any other compensation for the “use, forbearance or detention of money,” such as fees, grants of equity, the amount of any debt of others assumed, or just about any other contractually extracted consideration tied to the loan, might well be counted as interest too (although Texas has certain specified statutory exceptions for equity grants, loan assumptions and other common lender add-ons for certain specifically defined types of loans). And what constitutes a loan as opposed to an investment or purchase is a fact specific exercise. In general, any transaction that requires the absolute repayment of the funds advanced is subject to the risk of being re-characterized as a loan.

In light of this complexity, its important to choose your governing law carefully. As an example, the blog cites the Delaware Superior Court’s recent decision in Change Capital Partners Fund I, LLC v. Volt Electrical Systems, LLC, C.A. No. N17C-05-290 RRC (Del. Super. Ct.; 4/18). In that case, the Court rejected a challenge to a Delaware governing law provision in a receivables sale transaction that the plaintiff alleged was actually a loan – with a staggering 102% interest rate! The plaintiff contended that the transaction – which involved less than $2.5 million – should be governed by New York or Texas law.

Had the plaintiff succeeded in having the case governed by New York or Texas law, the transaction could have been recharacterized as a loan and may well have run afoul of either state’s usury laws. However, Delaware “provides no cap on interest rates, but instead allows interest to be charged in an amount pursuant to the agreement governing the debt.” Since that was the case – and because the Court ruled that Delaware law applied – there was no upside for the plaintiff in attempting to recharacterize the deal.

The blog says that there’s a particular lesson for PE firms, who often engage in small financing transactions with portfolio companies. Blindly calling for New York law to govern those arrangements can have severe consequences – including potential criminal liability – if the amounts involved are less than the $2.5 million cut-off for application of New York’s usury statute. It also points out that some states, such as Texas, have no upper limit on their usury statute. So, it suggests that Delaware – which does not have a usury statute – should be considered as a default option for these transactions.

Yeah, it sure would be nice if I could spell.  Of course, it’s “usury,” not “usery”, as I originally spelled it throughout this – and thanks to the member who kindly tipped me off to my error.

John Jenkins