Updated: Nov 3, 2022
The Basile Law Firm P.C. has been steadfast in representing our OTC Markets issuer clients in both federal and state courts around the country. To that end, we have been involved in dozens of federal court cases as toxic convertible notes lenders sued our client to try to enforce what are possible illegal contracts. The recent NY Court of Appeals decision, a decision that cannot be further appealed, reflects our long stated and correct legal position from the beginning that a convertible note is not only subject to New York’s usury laws, but the conversion discount (when the debt is converted to stock based on a mathematical formula presenting a discount to the trading price of a public company’s stock) must also be considered interest. The NY Court of Appeals also agreed with us and affirmed that a violation of New York’s criminal usury statute (charging interest 25% or over - Penal Law §190.40) voids such loans; the lender loses both principal and interest, that the loans are void ab initio and must be cancelled by the courts. The Court also agreed with us and reached the conclusion that such a conversion feature does not transform a loan to an equity investment upon conversion for purposes of the application of New York’s usury statute. The court further recognized there is no equitable remedy available to a usurer under NY law. Adar Bays, LLC v. GeneSYS ID, Inc., No. 51, 2021 BL 393765 (N.Y. Oct. 14, 2021).
Prior to the New York Court of Appeals decision, our firm had represented over a dozen OTC Market issuers against EMA Financial LLC, LG Capital Funding LLC, Adar Bays LLC, Blue Citi LLC, Coastal Investment Partners, L.P., Power Up Lending Group, Ltd. and Crown Bridge Partners, LLC, to name a few, raising the defense of violations of the criminal usury statute and we were constantly met with tremendous pushback from the federal courts, coming up with many “reasons” why they shouldn’t reach the conclusions that NY’s highest court just reached and is now the law.
The federal courts, albeit consistent, refused to recognize the conversion discount feature as interest; have held that the loan mysteriously transformed into an equity investment once the loan is converted to stock taking it out of a usury analysis, and if that weren’t the case, the criminal usury statute did not provide relief such as voiding the contract because New York’s civil usury forfeiture statute did not apply. Some law firms and other toxic lenders even tried to use that track record against us in other cases as well and in negotiations with the issuers to extract whatever they could from the company’s, claiming we took frivolous positions and lost. That is certainly not the case anymore as New York’s highest court agreed with us on all legal issues.
Some of our clients are no longer in business as a direct result of these lenders lawsuits. It’s also a direct result of being underfunded, being taken advantage of by toxic lenders with deep pockets and their relentless pursuit to collect on the notes by trying to force repayment with stock, that many federal courts allowed. However, the NY Court of Appeals has now stated what New York law is and has cleared the path for OTC Issuers to fight back hard against those note transactions.
In New York, a note that violates the usury statute is void ab initio. Legally, the effect is as it never was entered into to begin with. Szerdahelyi v. Harris, 490 N.E.2d 517 (N.Y. 1986). “Thus, loans [convertible notes] proven to violate the criminal usury statute are subject to the same consequence as any other usurious loans: complete invalidity of the loan instrument. Adar Bays, LLC v. GeneSYS ID, Inc., No. 51, 2021 BL 393765 at 15-16. See also Christopher Basile, CRIMINAL USURY AND ITS IMPACT ON NEW YORK BUSINESS TRANSACTIONS, 36 Touro L. Rev. 409 (2020).
An important issue identified by the NY Court of Appeals is the borrower’s responsibility to establish "intent". The current law in NY states that if the interest rate can be “gleaned” from the face of the document for payment of more than the legal rate of no greater than 25% interest, then the loan is criminally usurious on its face and intent is implied as a matter of law. See Blue Wolf Capital Fund II, L.P. v. AM. Stevedoring Inc., 961 N.Y.S.2d 86, 90 (N.Y. App. Div. 1st Dep't 2013).
However, the Court of Appeals wasn’t 100% certain about the “option” value (the conversion feature) and said it may have to be determined on a case-by-case basis. The Court went on to identify two court recognized valuation methods that can be used to value the option (conversion feature). And for clarity, if the math demonstrates the rate of interest exceeding 25%, it doesn't matter what the lender "thought". Thats not the "intent" the Court of Appeals was addressing. If the rate exceeds the statutory limits under New York's usury law(s), the transaction is void. Period. Our firm, with the help of experts in the field of options valuations, has already run the numbers under both judicially accepted formulas and the result is always the same – most of the lenders discount conversion features raises the interest rate above NY’s criminal usury rate.
We expect the Second Circuit Court of Appeals, based on the guidance of the New York Court of Appeals, to reverse the lower courts granting of summary judgment on liability and send the case back down to the trial court to litigate the issue of the conversion features value. We are also examining whether the New York Court of Appeals decision should prompt the lower federal courts to vacate all grants of summary judgment wherein the defendants raised the criminal usury defense but were shot down by those lower federal courts for the reasons stated above. The devastation those lawsuits had on these companies cannot be understated. Some judgments called for the continued conversions crippling a company's market cap, others for exorbitant money damages and many executives lives were ruined and shareholders lost on their investments.
To add a modicum of relief, some of these same toxic lenders may also be Securities Act violators as many of them failed to register as dealers as is required by securities laws, and the SEC has started enforcement actions resulting in court findings that buying convertible notes converting those notes to stock, and selling those shares into the public markets are dealer activity requiring registration – and the penalties for not doing so can be disgorgement of all profits made on those sales; cease and desist orders; lifetime penny stock bars; civil penalties and fines, and voiding/cancellation of the remaining notes. The SEC has brought enforcement actions against John M. Fife (Chicago Venture Partners, LP, Iliad Research & Trading, LP, St. George Investments, LLC, Tonaquint, Inc., Typenex Co-Investment, LLC), John D. Fierro (JDF Capital, Inc.), Benjamin Conde (Essex Global Investment Group), Justin Keener (JMJ Financial), Ibriham Almagarby (Microcap Equity Group, LLC), Robert Press (TCA Global Fund) Alexander Dillon (GPL Ventures Inc.) and Ed Liceaga (River North Equity, LLC) claiming securities act violations (dealer registration violations and control person liability). In all of these cases, the SEC has charged the individuals and their companies with failing to register as a dealer, and in one case (Almagarby), a judgment was entered awarding the SEC more than $1,000,000 in disgorgement, penny stock bars, cease and desist, civil fines and cancellation of all remaining securities (including convertible notes) finding that the buying and selling of convertible notes as a business violates the securities act without proper registration. (All parties are presumed innocent until proven otherwise).
New York Penal Law §190.40 prohibits the charge of more than 25% interest on loans under $2.5M, and its civil statute, Gen. Oblig. Law §5-511 voids all usurious loans under New York law. The Securities Act also voids transactions made or performed in violation of the Securities Act 15 U.S.C §78cc. If these lenders were required to register under the Act and didn’t, the Act voids those transactions as well.
It’s no coincidence that the results of violation of state or federal law are consistent. The takeaway is toxic convertible note lenders can be both usurers as well as securities act violators and as a CEO of a public company you may have a fiduciary responsibility to protect your company from these lenders and take action to cancel such transactions before they destroy your company and your shareholders. This is true even if you didn't know such violations existed at the time of making those agreements. The burden for compliance is the responsibility of the lender alone under both state and federal law. You should immediately seek counsel of your choice to discuss your options, whether you have already been victimized or are currently being sued, as to what legal steps are available to you.
If you are the CEO of a public company and have taken convertible floor-less toxic debt, issued warrants, or entered into an equity line of credit and you want to know more about your rights in connection with these new developments and do not have counsel, feel free to reach out to me at email@example.com.