Florida Courts Should Apply New York’s Adar Bays Analysis To Determine Usury – Trials & Appeals & Compensation

Usurious loans have been the scourge of finance since early
times. Despite being condemned as wrong and sinful for over 4000
years, usurious interest rates always seem to find their way into
modern financial transactions. Less than a century ago, the Florida
Supreme Court stated that the “purpose of the statute
prohibiting usury is to bind the power of creditors over
necessitous debtors and prevent them from extorting harsh and undue
terms in the making of loans.” Chandler v. Kendrick,
146 So. 551, 552 (Fla. 1933). Unlike New York’s well developed
body of usury laws, today, Florida courts provide little guidance
as to what constitutes interest on a loan. Nevertheless, Florida,
like many other states, has imposed a cap on the amount of interest
a lender can charge.¹ Personally, I
don’t believe interest changes its shape just because you cross
a state’s border.

Florida Usury Statutes

Florida law specifies two levels of usury, civil and criminal.
Under Florida’s usury laws, it is considered usurious and
unlawful to charge a rate of interest more than 18% for any loan,
money advance, line of credit, or other obligation where the
principal balance is $500,000 or less. See Fla.
Stat.§ 687.03(1). A creditor who willfully violates
Florida’s usury law is liable to the borrower for double the
amount of interest collected. See Fla. Stat. §
687.04; Jersey Palm-Gross, Inc. v. Paper, 639 So.2d 664,
667 (Fla. 4th DCA 1994). For criminally usurious loans, the lender
forfeits all interest and the entire debt becomes unenforceable.
Fla. Stat. § 687.071(7). If liable for criminal usury under
Fla. Stat.§ 687.071(2) and (3), the lender is facing enhanced
penalties ranging from first-degree misdemeanor to a third-degree
felony. The lender may also be liable for damages double the amount
of interest collected and borrower’s attorney’s fees. Fla.
Stat. §§ 687.147; 687.04.

Fla. Stat. § 687.03 prohibits lenders from reserving,
charging or obtaining “an advance of money, line of credit,
forbearance to enforce the collection of any sum of money, or other
obligation a rate of interest greater than the equivalent of 18
percent per annum simple interest, either directly or indirectly,
by way of commission for advances, discounts, or exchange, or by
any contract, contrivance, or device.” Further, if the loan,
line of credit, or promissory note exceeds $500,000 in value or
amount, “it shall not be usury or unlawful to reserve, charge,
or take interest thereon unless the rate of interest exceeds the
rate prescribed in §
687.071.”² Additionally, if the
loan exceeds $500,000, “stock options and interests in
profits, receipts, or residual values are examples of the type of
property the value of which would be
excluded³ from calculation of
interest” under Fla. Stat. §
687.03(5)(a)⁴ and §
687.03(5)(b)⁵. This is of course
obvious because it is next to impossible to predict how much a
lender can make based on future sales. However, fixed percentage
discounts are a different story as such provisions guarantee the
lender the same return for each conversion made, no matter what the
value of the property is.

In accord, Florida courts impose four requisites for usurious
transactions: (1) a loan, express or implied; (2) an understanding
between the parties that the money lent shall be returned; (3)
payment or agreement to pay a greater rate of interest than is
allowed by law; and (4) a corrupt intent to take more than the
legal rate for the use of the money loaned. Video Trax, Inc. v.
NationsBank, N.A., 33 F. Supp. 2d 1041, 1056 (S.D.Fla. 1998)
citing Dixon v. Sharp, 276 So. 2d 817, 819 (Fla. 1973);
See also Pinchuck v. Canzoneri, 920 So. 2d 713, 715 (Fla.
4th DCA 2006); Jersey Palm-Gross, Inc. v. Paper, 639 So.
2d 664, 666 (Fla. 4th DCA 1994). .Similarly, New York law allows
usurious intent to be established when a borrower sufficiently
“intends to borrow,” rather than to “engage in a
joint transaction or exchange money for some other reason,”
and a lender intends to accept such payment. Szerdahelyi v.
Harris, 67 N.Y.2d 42, 46 (N.Y. 1986); see Adar Bays, LLC.
v. GeneSYS ID, Inc., 37 N.Y3d 320, 339 (N.Y. 2021) (holding
that “stock conversion options should be considered when
determining the interest charged on a loan transaction and usurious
loans to corporations” because “usurer usually seeks to
conceal the usury, and to accomplish [the] purpose by indirect
methods”) (quoting Meaker v. Fiero, 145 N.Y. 165, 169
(1895)).

In determining usury, the court looks to the substance of the
transaction, rather than the form. In re Marill Alarm Sys.,
Inc., 81 B.R. 119, 124 (S.D.Fla. 1987). This is consistent
between New York and Florida. Whether a transaction is either
civilly or criminally usurious is determined “at the
inception of the loan.”Oregrund Ltd. P’skip
v. Shelve, 873 So.2d 451, 458-59 (Fla. 5th DCA 2004); Home
Credit Co. v. Brown, 148 So.2d 257, 259 (Fla. 1962); see
alsoTchlenoff v. Dyner, 36 N.Y.S.2d 514 (Sup. Ct.
1942). Most importantly, a corrupt intent must be established: not
if the lender received more interest but if the lender intended to
do so. This is also consistent with New York law. Adar Bays,
LLC v. GeneSYS ID, Inc., 341 F. Supp. 3d 339, 353 (S.D.N.Y.
2018). Corrupt intent is shown by evidence of the lender knowingly
charging or receiving excessive interest. Oregrund Ltd.
P’ship v. Sheave, 873 So.2d 451, 459 (Fla. 5th DCA 2004)
(citations omitted). In both, Florida and New York, an illegal
agreement is void ab initio.⁶
While the Florida usury statute prescribes what constitutes a
usurious interest rate on a loan, it does not enumerate which
charges are considered in interest calculation. Thus, the Florida
courts have provided us with limited guidance of what charges are
deemed interest for purposes of usury. However limited, some
Florida courts have identified certain fees, advances, and expenses
that can and may be considered interest on a loan. Florida courts
hold that if a borrower is required to pay a bonus or other
consideration at the inception of the loan as an inducement to the
lender to make the loan, such inducement may be considered interest
and can render an otherwise proper loan usurious.
SeeCooper v. Rothman, 63 Fla. 394, 57 So. 985,
988 (1912); JerseyPalm-Gross, Inc. v. Paper, 639
So.2d 664, 667 (Fla. 4th DCA 1994), aff’d, 658 So.2d
531 (Fla. 1995). Similarly, if a lender retains a substantial
portion of the loan proceeds without allowing a corresponding
abatement of interest on the amount retained, that retention
effectively increases the interest charged on the amounts actually
advanced to the borrower, thereby rendering an otherwise proper
loan usurious. See Mindlin v. Davis, 74 So.2d 789, 793
(Fla. 1954). This is typically referred to as an “original
issue discount”. The Florida Supreme Court held that where the
contract is not usurious at the inception, it is not rendered
usurious because of exercise of the option of prepayment by the
maker and the demand and receipt of interest by payee for the full
length of the contract. Dezell v. King, 91 So.2d 624 (Fla.
1957). This “prepayment” feature is a typical provision
in convertible notes, and even several NY courts have struggled on
whether to include such charges as interest. LG Capital
Funding, LLC v. PositiveID Corp., No. 17-CV-1297, [2019 BL
282324], 2019 WL 3437973, at *11 (E.D.N.Y. July 29, 2019)
(collecting cases); see also e.g., Coastal Inv. Partners, LLC
v. DSG Global, Inc., No. 17-CV-4427, [2018 BL 201399], 2018 WL
2744719, at *7 (S.D.N.Y. June 6, 2018); Feldman v. Kings
Highway Sav. Bank, 102 N.Y.S.2d 306, 307 (App. Div. 2d Dept
1951). A lender; therefore, cannot hide interest in a form of fees
and advances to disguise usury in a loan. Treatment of these types
of charges are consistent between Florida and New York.

But what about the conversion feature of a convertible note and
the discount it provides to the lender. How should Florida treat
that? New York’s highest court has said a fixed discount
(floating rate) in a convertible note does constitute interest. My
colleagues in our New York office did a masterful job challenging a
convertible notes conversion discount feature which the New York
Court of Appeals ruled that such charge is interest under New York
law. The focus is on the “value” of the conversion
feature that was bargained for, and reserved to the lender, at the
time the transaction was entered into. That “value”
doesn’t change just because you cross state lines.

New York Court of Appeals ruled that convertible loans are
subject to Usury Laws

A fairly novel but critically important issue was decided in New
York regarding stock conversion options as part of the usury
calculation. In Adar Bays, the Second Circuit certified
two questions to the New York Court of Appeals:

1. “Whether a stock conversion option that permits a lender
   in its sole discretion, to convert any outstanding balance to
   shares of stock at a fixed discount, should be treated as interest
   for the purpose of determining whether the transaction violates
   N.Y. Penal Law § 190.40, the criminal usury law; and




2. If the interest charged on a loan is determined to be
   criminally usurious under N.Y. Penal Law § 190.40, whether the
   contract is void ab initio pursuant to N.Y. Gen. Oblig. Law §
   5-511.”

Adar Bays, LLC v. GeneSYS ID, Inc., 962 F.3d 86, 94 (2d
Cir. 2020).

Both questions were answered by New York’s highest court in
the affirmative providing clarity that corporate loans with
convertible discount options are subject to usury laws. Analyzing
the second question first, the court concluded that, text, history
and legislative purpose of the NY usury laws show that if a
borrower successfully proves a defense of usury, the usurious loans
are void ab initio, and thus, unenforceable. In answering
the first question, the Court noted that the value of a
floating-price convertible option, such as a stock conversion
option, is considered interest. In this unprecedented case, the
plaintiff issued a defendant a loan for $35,000 with 8% interest
rate that would mature in one year. The loan agreement specified
that the plaintiff could —at his sole
discretion—convert some or all of the debt into shares of
defendant’s stock at a discount of 35% from the lowest trading
price of defendant’s stock over a 20-day period prior to the
date on which the plaintiff requests a conversion. Deciding in
favor of the borrower, the Court further noted that the value of
the floating-price option and the methodology of calculation is
left to the fact finder (jury or judge). Clarifying that the law
has not changed in almost a century, the New York Court of Appeals
brought relief to many injured borrowers, especially small publicly
traded companies..

Will Florida follow New York’s ruling in Adar
Bays?

I believe it will. The value conferred by the conversion
discount is bargained for by the lender before the transaction is
consummated. It is not the type of contingency as is contemplated
in Kraft v. Mason, 668 So.2d 679, 684 (Fla. DCA 4th 1996)
(“[A] loan or financing agreement will not be deemed usurious
when repayment is made subject to the occurrence of a
contingency.”). The convertible note reserves this additional
interest charge for the benefit of the lender, and that additional
charge has a value. The point of Adar Bays is for the
courts to determine the value of the conversion option to get a
real, true picture of what the lender intended to charge and did in
fact reserve to itself.

In Continental Mortgage Investors v. Sailboat Key,
Inc., a Massachusetts corporation (CMI) made a $3,500,000
commercial loan to a Florida real estate development corporation
(Sailboat). Continental Mortgage Investors v. Sailboat Key,
Inc., 354 So.2d 67 (Fla. 3d DCA 1977). While the main issue in
the case was which choice of law should govern, another important
issue, answered by the District Court of Appeals, and the key issue
for our purposes, is whether the value of the borrower’s
corporate stock was correctly considered as interest where the
stock had a specific value at the time it was issued to the lender
and such value was not contingent upon the success of the venture
which was financed by the loan. Based upon the uncontested
testimony, the judge found that at the time the stock was issued to
CMI, the parties agreed that the total value of all the Sailboat
Key stock was $1,975,000 and, therefore, the value of CMI’s 50%
equity was $987,500. CMI basically contends that the value of the
equity in the project which it received (a so called “equity
kicker”) substantially depended upon the success of the
venture and should have been excluded from the calculation of
interest as provided in Section 687.03(4), Florida
Statutes (1974). Id. at 72-73. However, the Appellate
Court held that the trial judge did not err in calculating it as
interest because the evidence showed the stock received by CMI was
worth $987,500 at that time and this value did not depend upon the
success of the venture. Id. The Florida Supreme Court did
not answer this question since it found Massachusetts law to be
controlling and remanded the case to the trial court.

For instance, the Fourth District Court of Appeals explained
that when a lender is compensated for out-of-pocket expense for
services provided, courts will deem the expense as a service
charge, not interest for purposes of usury. Abromowitz v.
Barnett Bank, 356 So.2d 329 (Fla. 4th DCA 1978). Holding that
a “mortgage loan discount” deducted from a loan proceeds
is a question of fact and cannot be decided in a summary judgment
proceeding, the court stated that it is irrelevant whether the
charge is titled “mortgage loan discount” or a
“service charge” because the purpose of the charge
determines if it is interest, not the title of it. Id. In
that case, a $4,000 fee was charged by the lender as a mortgage
loan discount but was in fact, a service charge. Id. Based
on the testimony from the bank’s president “only a portion
of the $4,000” was used to pay for the inspection asserting
that a portion of the $4,000 could be treated as interest but even
if the court finds that the interest rate exceeds 10% once
remanded, the loan is still not usurious unless corrupt intent is
present, which is a question of fact. Id. at 330-31.

Similarly, an agreement in the form of an investment in which
the return is labeled “profit,” as opposed to
“interest,” will be deemed a loan if the substance of the
transaction is a loan. In Pinchuck v. Canzoneri, the
borrower and lender entered into an agreement in which the borrower
would repay the amount borrowed plus an “investment
profit.” Pinchuck v. Canzoneri, 920 So. 2d 713 (Fla.
4th DCA 2006). The effective interest rate amounted to 144 percent
of return on principal. Id. at 715. The court found that
the term “investment profit,” which was used to describe
the amount to be paid above the principal, could not be used to
conceal usury. Id.

It is only a matter of time before Florida courts catch up to
this novel issue of conversion discount options used to disguise
usury. As the highest court in New York resolved this issue by
protecting the borrower from these shylocking businesses that prey
on the desperate, different jurisdictions will eventually follow.
Unlike New York, where usury is claimed only as an affirmative
defense, Florida usury law allows a borrower to assert a claim of
usury either as a cause of action⁷ or
an affirmative defense. Florida; however, has not yet answered
whether a convertible discounted option is subject to usury law,
but it is clear: if at the inception of the agreement, the amount
of money is reasonably ascertained, courts will look at it as an
interest. On the other hand, if the compensation is speculative, it
is not interest. Consequently, the borrower carries the burden to
prove that the payment obligation is clearly ascertained at the
inception of the loan. As in New York, the court need not decide
the value or the method of calculating the conversion option but
only if the value can be reasonably established at the inception of
the agreement. Based on the similarities between both
jurisdictions, Florida will likely follow New York’s highest
court finding that floating-price discount options must be used in
usury analysis because often, the value of the discount option is
reasonably ascertainable at the inception of the loan, as Florida
requires.

Footnotes

1. The maximum rate of interest is 18% for any loan,
money advance, line of credit, or other obligation where the
principal balance is $500,000 or less. See Fla. Stat.
§ 687.03(1). If the interest rate is more than 25% but less
than 45%, it is a criminal offense of second degree misdemeanor.
Fla. Stat. § 687.071(2). Interest rate exceeding 45% per annum
is punishable as a third degree felony. Fla. Stat. §
687.071(3).

The Texas maximum interest rate is 10% per annum, and if the
maximum rate exceeds, it is punishable as a misdemeanor. See Tex.
Finance Code §§ 304.001; 304.002. In New York, the
maximum interest rate is 16% per annum for loans under $250,000
(unless to a corporation, but subject to criminal usury), and if
exceeded, the lender is liable for civil usury; the agreement is
void ab initio. N.Y. Gen. Oblig. Law §§ 5-501;
5-511. If charged more than 25% per annum, the lender is liable for
criminal usury in the second degree. N.Y. Penal Law § 190.40.
In Massachusetts, if the interest rate is more than 20% per annum a
person is liable for criminal usury and “shall be guilty of
criminal usury and shall be punished by imprisonment in the state
prison for not more than ten years or by a fine of not more than
ten thousand dollars, or by both such fine and imprisonment.”
Mass. Gen. Laws Ch. 271, § 49(a).

2.See Fla. Stat. § 687.071(1).

3. See Fla. Stat. § 687.03(4).

4. Fla. Stat. § 687.03(5)(a) states stock options
“[s]hall apply only to loans, advances of credit, or lines of
credit made on or subsequent to July 1, 1979, and to loans,
advances of credit, or lines of credit made prior to that date if
the lender has the legal right to require full payment or to adjust
or modify the interest rate, by renewal, assumption, reaffirmation,
contract, or otherwise.”

5. Fla. Stat. § 687.03(5)(b) states stock options
“[s]hall not be construed as diminishing the force and effect
of any laws applying to loans, advances of credit, or lines of
credit, other than to those mentioned in paragraph (a), completed
prior to July 1, 1979.”

6. “A contract which violates a provision of the
constitution or a statute is void and illegal and will not be
enforced in our courts.” Cardegna v. Buckeye Check
Cashing, Inc., 894 So.2d 860, 864 (Fla. 2005) citing
Harris v. Gonzalez, 789 So.2d 405, 409 (Fla. 4th DCA
2001).

7. Oregrund Ltd. P’ship v. Sheave, 873 So.2d
451, 453 (Fla. 5th DCA 2004) (Florida district court reversed the
dismissal of a usury claim, concluding that appellants sufficiently
stated a cause of action based upon violation of the usury
statutes).

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.