Commercial Division Blog

Posted: December 2, 2019 / Categories Commercial, Usury

Court Looks to Substance of Agreement, Not How it is Styled, in Upholding Usury Claim

On November 19, 2019, Justice Nowak of the Erie County Commercial Division issued a decision in McNider Mar., LLC v. Yellowstone Capital, LLC, 2019 NY Slip Op. 33418(U), holding that the court would look to the substance of an agreement, not how it was styled, in upholding a usury claim, explaining:

Defendants move this Court to dismiss all three causes of action contained in the amended complaint, all of which depend upon the allegation that the July and October agreements constituted criminally usurious loans instead of purchases of accounts receivables. If a transaction is not a Joan, there can be no usury, however unconscionable the contract may seem to be. Defendants contend that the documentary evidence demonstrates as a matter of law that the July and October agreements were purchases of accounts receivable and not loans. In determining whether a transaction is usurious, the law looks not to its form, but to its substance, or real character.

After analyzing specific MCA agreements, many New York courts have found that they constitute legitimate purchases of accounts receivables instead of loans with usurious interest rates. Courts that found otherwise, that MCA agreements were usurious loans disguised as purchases of accounts receivable, typically found no provisions for forgiveness or modification of the loans, such as viable and enforceable reconciliation provisions, in the event that the funding companies could not collect the daily amounts required.

In K9 Bytes, Inc. v Arch Capital Funding, LLC, 56 Misc 3d 807 (Sup Ct, Westchester County 2017), the court considered a series of merchant agreements. Several of them required that the funding company "shall, upon [the merchant's] request," reconcile the merchant's account according to the specified percentage. As a result, the court found that such agreements did not create an unlawful debt. Another agreement, however, did not include a reconciliation provision, and the court held that it cannot find, as a matter of law, that the transaction is not a loan.

Focusing on the reconciliation provision in a given merchant agreement is appropriate because it often determines the risk to the funding company. If the funding company truly is collecting a specified percentage of accounts receivable, then the funding company bears the risk of a downturn in the merchant's business. The specified percentage typically is replaced by a fixed payment (as it was here), but if that payment is reconciled when accounts receivable drop below the merchant's original estimation, then it may take the merchant far longer to repay the amount advanced than the funding company had anticipated.

If, however, the merchant is unable to adjust fixed payments in the event of a reduction of its accounts receivable, and the funding company can collect the amount due and owing by way of a personal guarantee and confession of judgment, there is far less risk to the funding company. Therefore, whether the merchant may reconcile its fixed payment amount when there is a reduction of accounts receivable is often determinative of whether repayment is absolute or contingent. If repayment is absolute, then the arrangement must be considered a loan as opposed to a purchase of accounts receivable.

In this case, the court finds that plaintiffs have demonstrated that the reconciliation provisions contained in the addenda to the July and October agreements were illusory. First, the court cannot find from the language in the agreements that Yellowstone had any duty to reconcile. In fact, Yellowstone likely could refuse to even consider reconciliation if it contended that McNider Marine failed to sufficiently document a basis for it. Furthermore, even if Yellowstone was required to reconcile, there was no time to do so because McNider could request reconciliation only within five business days following the end of a calendar month. McNider Marine defaulted on December 16, 2016, so it could not request reconciliation until the first week of January 2017. Yellowstone filed for a judgment by confession on December 22, 2016 and obtained that judgment on December 28, 2016.

The notion of reconciliation for McNider Marine appears particularly futile because the fixed daily payment in the October agreement was not a good faith estimate of 15% of its receivables to begin with inasmuch as there was no evidence that the receivables had increased over 40% from the July estimate. Without the right to effectively reconcile the fixed dollar amount, the agreement resulted in a loan payable over a fixed term with a criminally usurious interest rate in excess of 285%.

(Internal quotations and citations omitted).

New York's usury laws can sometimes provide a defense to payment: the interest rate in an agreement can be so high that a court will not enforce it. Contact Schlam Stone & Dolan partner John Lundin at if you or a client have a question regarding whether the interest rate in an agreement or note is legal.