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Litigation Funding Agreements and Usury

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  • Posted on: Dec 7 2018

If anyone is wondering why seemingly high-cost “loans” by litigation funding companies are not considered usurious, the Appellate Division, First Department, explained why in Cash4Cases, Inc. v. Brunetti (December 6, 2018).

First, however, a bit about usury.  Section 5-501 (1) of New York’s General Obligations Law, which addresses civil usury, provides that, with some exceptions, “[t]he rate of interest, as computed pursuant to this title, upon the loan or forbearance of any money, goods, or things in action … shall be six per centum per annum unless a different rate is prescribed in section fourteen-a of the banking law.”   Section 14-a (1) of New York’s Banking Law provides that the maximum rate of interest provided for in GOL 5-501 is 16% per annum.  GOL 5-501 (2) prohibits charging a rate of interest in excess of the rate set forth in GOL 5-501 (1).

 

A finding of usury by a Court is significant.  “The consequences to the lender of a usurious transaction can be harsh: the borrower is relieved of all further payment—not only interest but also outstanding principal, and any mortgages securing payment are cancelled.”  Seidel v. 18 East 17th Street Owners, Inc., 79 N.Y.2d 735, 740 (1992); see also, Roopchand v. Mohammed, 154 A.D.3d 986, 988 (2nd Dep’t 2017).  Due to the harshness of such a rule, civil liability for usury “is only satisfied by clear and convincing evidence.”  Freitas V. Geddes Savings and Loan Ass’n., 63 N.Y.2d 254, 260-61 (1984).

Further, in determining whether a loan is usurious, it is not enough to simply look at the nominal interest rate.  The nature of the entire transaction must be analyzed.  As the Court noted in Freitas:

Section 14-a of the Banking Law authorizes the Banking Board to establish the maximum rate of interest to be employed in certain lending arrangements, including conventional home mortgage loans. The section further provides that such rate “shall include as interest any and all amounts paid or payable, directly or indirectly, by any person, to or for the account of the lender in consideration for the making of a loan or forbearance” (Banking Law, § 14-a subd 2 [then § 14-a, subd 2, par (b)]) and that the Banking Board may adopt regulations to effectuate this policy (Banking Law, § 14-a, subd 3 [then § 14-a, subd 2, par (a), cl 2]). The purpose of section 14-a (subd 2, par [b]) of the Banking Law is to “curb the use of points and other charges which increase the lender’s return” and to empower the Board “to prescribe by regulation the specific fees and charges to be included as interest on loans subject to the ceilings prescribed by the Board.” (Memorandum of New York State Banking Dept, Bill Jacket, L 1968, ch 349, p 4.) The text and legislative history of section 14-a of the Banking Law are silent as to the mode of disclosure, if any, to be undertaken by the lender in a mortgage loan transaction.

Freitas, 63 N.Y.2d at 258 – 59.

The Plaintiff in Cash4Cases, is a litigation funding company that purchased an interest in defendant’s personal injury action.  Pursuant to the parties’ agreement, Cash4Cases advanced defendant $77,000 “at a ‘Compound Monthly Carrying Charge’ of 3.2% and an ‘Annual Percentage Rate’ of 45.93%.”  In return, defendant agreed to repay the obligation from the proceeds of his underlying personal injury case.  Significantly, repayment of the “advance” was contingent on defendant prevailing in the underlying action.

Arguing that the “advance” was usurious and unconscionable, the defendant failed to repay Cash4Cases from the proceeds of the underlying personal injury settlement.  The First Department disagreed and granted Cash4Cases’ motion for summary judgment in lieu of complaint.  In so doing, the Court reiterated that the defense of usury can only be utilized where the repayment obligation springs from a loan.  Relying on Rubenstein v. Small, 273 A.D. 102, 104 (1st Dep’t 1947), the Cash4Cases Court held that “[t]o constitute a loan, the agreement must ‘provide for repayment absolutely and at all events or that the principal in some way be secured as distinguished from being put in hazard.’”

The Court held that agreements such as those used by Cash4cases are not loans because the “advances” do not have to be repaid, and thus are “entirely contingent” on whether the underlying action is successful.  Accordingly, a usury defense was unavailing.

For a variety of the following reasons, the Court also found that the parties’ agreement was not unconscionable: the Cash4Cases defendant did not demonstrate the absence of “meaningful choice” in entering into the agreement; the terms of the agreement were not “unreasonably favorable” to Cash4Cases; the interest rates were fully disclosed;  defendant was represented by counsel in conjunction with the transaction; and, funds were received by defendant “with no guaranteed obligation to repay, except from the proceeds, if any, recovered in his personal injury action.”  Thus, despite a high interest rate, “given the contingent nature of the transaction, the agreement was not overly unfavorable to defendant” and, therefore, not unconscionable.

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