Article courtesy of Kevin P. Braun of Morgan, Lewis & Bockius LLP
Convertible notes with default interest exceeding the Massachusetts statutory maximum violated the Massachusetts Usury Act, since they were not registered with the Massachusetts Attorney General’s office; however, the court declined to void the loans as permitted under the Act, but ordered the notes to be reformed to remove the usurious provisions so Lender could recover the money it loaned in good faith to Borrower. Auctus Fund, LLC v. Drone Guarder, Inc., No. CV 21-11193-WGY, 2023 WL 2401014 (D. Mass. Mar. 8, 2023).
Actus Funds, LLC (“Lender”) and Drone Guarder, Inc. (“Borrower”) entered into two loan transactions where Borrower executed and delivered to Lender a $165,000 12% convertible interest rate promissory note (the “January Note”) and a $125,000 12% convertible interest rate promissory note (the “May Note”). The notes indicated that they (1) were subject to default interest at the lesser of 24% per annum and the maximum allowed by law, (2) began accruing interest on the day of execution and (3) were due in full, with accumulated interest, on the respective maturity date. They were also convertible to common stock of Borrower, at a rate of 30% (or 70% if there was a default) of the market price of the stock.
Borrower failed to pay the notes at maturity and Lender demanded payment of principal, accumulated interest, penalties and other fees on both notes. Lender sued Borrower and alleged that Borrower breached the contract, along with a variety of other claims. Lender never enforced the default interest rate on the May Note, but evidence presented indicated that it did do so for the January Note.
The District Court for the District of Massachusetts, applying Massachusetts law, found that Borrower breached its contract with Lender, as there was a valid contract between the parties and Borrower had a duty to pay Lender the amounts agreed.
Borrower countered Lender’s claims with a claim that the notes were usurious. The parties did not dispute that Massachusetts law governed the notes, despite the governing law provision on the face of the notes indicating Nevada law. Massachusetts law allows usurious loans to be voided under certain circumstances and the Massachusetts Usury Act prohibits contracting for “interest and expenses the aggregate of which exceeds . . . twenty per cent per annum” of the loan. Id. at 7. However, so long as such loans are registered with the Massachusetts Attorney General’s office, such loans are permissible per Mass. Gen. Laws ch. 271 § 49(d), which the court referred to as a “glaring deficiency in Massachusetts law,” id. This registration is typically done by the Lender. However, in this case, Lender did not file the loans with the Massachusetts Attorney General’s office.
The court found the interest rate applicable to the notes had the potential to exceed the statutory maximum because the notes were subject to a 24% default interest rate and the conversion tool allowed the difference between market value and the amount that Lender actually pays for the stock in a conversion situation to far exceed 20%. Even though the usurious default interest rate on the May Note was never enforced, the court held that it still violated the Massachusetts Usury Act because it contained the usurious provisions. The court noted that it would be inequitable to void the entire loans, but ordered the loans be reformed to remove the usurious provisions so that Lender could recover the money it loaned Borrower in good faith.
