Auctus Fund, LLC v. Sunstock, Inc., 405 F. Supp. 3d 218 (D. Mass. 2019)
Sunstock Inc., (the “Borrower”) issued convertible promissory notes to Auctus Fund, LLC (“Auctus”) and EMA Financial, LLC (“EMA”, and each a “Lender”, and collectively the “Lenders”) in 2017. Both Lenders had a provision in their respective promissory notes where in the event of a default, the Borrower would owe 150% of (1) the principal yet to be paid; (2) all unpaid interest; and (3) interest on the unpaid amounts (the “Default Provision”). The Lenders also had the right to convert the sum owed into stock of the Borrower. The Borrower defaulted and the Lenders won an earlier summary judgement for breach of contract.
In determining damages, the court began with analysis of the choice of law provision in the notes, and applied the Restatement (Second) of Conflict of Laws § 187(2) (1971) which presumes the parties’ choice of law applies unless: (a) the chosen state has no substantial relationship to the parties, or (b) application of the law of the chosen state would be contrary to fundamental policy of a state which has a materially greater interest than the chosen state.
The Auctus notes were said to be governed by Nevada law and the EMA notes were said to be governed by New York Law. The Borrower is a Delaware corporation, with a headquarters in California, claiming to be investing in California convenience stores and California real estate; Auctus is a Delaware limited liability company, based in Boston; and EMA was organized in Delaware with a headquarters in New York City.
The court found no relationship between the parties and the state of Nevada, and no otherwise reasonable basis for the choice of Nevada law in the Auctus notes. In determining which law to apply, the court examined the relevant states with an interest: Delaware, Massachusetts and California, and determined the California had the greatest interest due to the Borrower using the proceeds for California investments as well as California’s concern to protect debtors from any usurious loans.
While Nevada had no usury law, California’s usury limit at the time was 2% lower than the interest rate on the Auctus notes. The court concluded the Auctus notes were therefore usurious and limited Auctus’ recovery to unpaid principal, set off by interest previously paid. In addition, citing California law, the court found the Default Provision did not take into account the actual damages sustained by the party aggrieved by the breach, and therefore held it unenforceable.
With regard to the EMA notes, the court considered the same public policy concerns of California wishing to protect its debtors, however, the New York choice of law provision was not unreasonable considering it is the location of EMA’s headquarters and the court therefore held it to be valid. While there was no New York usury violation, and the court upheld the default interest rate of 24%, it nevertheless found the Default Provision to be “grossly disproportionate to the amount of actual damages” and therefore held it be an unenforceable penalty.
Contributed by Kevin Braun of Morgan Lewis & Bockius LLP