First Department Reverses, Inter Alia, Judgment of Foreclosure and Sale, Finding Questions of Fact As To Whether LLC Was Formed Solely To Avoid Usury Laws
Print Article- Posted on: Jan 17 2025
As readers of this BLOG know, we frequently address issues involving mortgage foreclosure and usury.[1] Today’s article involves both issues. By way of background, and as explained in prior articles, usury statutes were developed to “protect desperately poor people from the consequences of their own desperation.” Seidel v. 18East 17th Street Owners, Inc., 79 N.Y.2d 735, 740 (1992) (citations and internal quotation marks omitted).
“To successfully raise the defense of usury, a debtor must allege and prove by clear and convincing evidence that a loan or forbearance of money, requiring interest in violation of a usury statute, was charged by the holder or payee with the intent to take interest in excess of the legal rate.” Blue Wolf Capital Fund II, L.P. v. American Stevedoring Inc., 105 A.D.3d 178, 183 (1st Dep’t 2013).
Pursuant to General Obligations Law §5-501(1), interest on a loan or forbearance “shall be six per centum per annum unless a different rate is prescribed in section fourteen-a of the banking law.” GOL §5-501(2) prevents individuals or entities from charging interest rates exceeding those permitted pursuant to GOL §5-501(1). Banking Law §14-a(1) provides that the “maximum rate of interest provided for in section 5-501 of the general obligations law shall be sixteen per centum per annum.” Because Corporations are “generally the antithesis of … desperately poor people”, they are “ordinarily barred from asserting a usury defense.” Seidel, 79 N.Y.2d at 740 (citations, footnote and internal quotation marks omitted). See also GOL § 5-521(1). However, a corporation can assert usury as a defense to the extent that the usury is criminal under Section 190.40 of New York’s Penal law, which makes interest on a loan or forbearance that exceeds twenty-five percent per annum a felony. GOL § 5-521(3). See also Roopchand v. Mahammed, 154 A.D.3d 986, 988 (2nd Dep’t 2017) (citation omitted).
Further, in addition to the stated interest rate on the subject note, other factors are used in determining the actual interest rate for usury purposes. For example, in American E Group LLC v. Livewire Ergogenics Inc., 2022 WL 2236947 (2nd Cir. 2022) (applying New York law), the Court affirmed the District Court’s refusal to enforce a promissory note and the dismissal of the lender’s action to enforce the note in light of the borrower’s criminal usury defense when certain charges were deemed to be interest and added to the note rate. See also Frost v. Collateral Partners, LLC, 219 A.D.3d 587, 588 (2nd Dep’t 2023) (finding that since borrower was charged an insurance fee for declined insurance coverage, there was a question of fact as to whether “the purported insurance fee was, in actuality, additional interest on the loan,” precluding summary judgment.); Blue Wolf, 105 A.D.3d at 183 (“If an instrument provides that the creditor will receive additional payment in the event of a contingency beyond the borrower’s control, the contingent payment constitutes interest within the meaning of the usury statutes.”)
The Appellate Division, First Department, addressed these issues in NY 2015 Boat LLC v. Shapiro, decided on January 16, 2025. The defendant brothers in NY 2015 needed money to make improvements to the home they grew up in and to satisfy some outstanding financial obligations. However, due to, inter alia, poor credit ratings, banks denied their loan applications. The brothers, therefore, searched the internet and found a broker who advised them that he could find them a high-interest loan – which he did. Shortly before closing, the broker sent the brothers numerous documents including, but not limited to, a note and mortgage and a deed transferring the house to an entity called 2435 Kingsland LLC (the “Fictitious LLC.”) that the brothers never heard of before. The loan, and related, documents listed the Fictitious LLC. as the borrower. The broker explained the existence of the Fictitious LLC, and the brothers’ transfer of the house to that entity, by stating that the lender only made commercial loans. The lender also “provided” a lawyer to represent the brothers in the loan transaction.
The subject promissory note “provided for an interest rate of 12%, as well as an exit fee amounting to $7,500”. Significantly,
[a]t the end of the closing, [one of the brothers] received a breakdown of the loan funds’ disbursement. Various fees, including $9,000 to [the lender] as a commitment fee and $4,250 to [lender]’s attorney, were deducted from the $300,000 the [brothers] were to receive, resulting in net proceeds of $250,750. From that $250,750, $3,000 was to be paid to [the broker] as a broker’s fee, $750 to [the brothers’ attorney], and $143,307.96 to a title company retained to pay off the [brother]s’ debts and judgments. [The Lender] disbursed the remaining $103,692.04 to an account opened in [the Fictitious Corp.]’s name. However, that account had been opened by [the broker] with his own social security number. As a result, the [brothers] could not access this account and did not receive these funds.
The trial court granted the lender summary judgment and a judgment of foreclosure and sale and determined that over $365,000.00 was due on the underlying debt. The First Department unanimously reversed. The Court found that “[u]nder these circumstances presented, the borrower’s status as an LLC did not bar the [brother]s’ usury defense. Specifically, the circumstances surrounding the loan raise at least a question of fact as to whether [the lender] used the corporate form to conceal a usurious loan to the [brothers].” (Citing Schneider v. Phelps, 41 N.Y.2d 238 (1977), in which the Court addressed the use of “dummy” corporations to circumvent usury laws.)
Jonathan H. Freiberger is a partner and co-founder of Freiberger Haber LLP. This article is for informational purposes and is not intended to be and should not be taken as legal advice.
[1] To find one of our numerous BLOG articles related to mortgage foreclosure, visit the “Blog” tile on our website and enter “mortgage foreclosure” in the “search” box. We have also addressed numerous issues involving usury. See, e.g., [here], [here], [here], [here], [here], [here].