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How Greedy Can You Be In a Penalty?

business contract lawyer

Ever sign a contract where the penalty provisions for being a little bit late seemed somewhat high? Compared to the amount owed, perhaps even excessive? For instance, in a commercial lease where you pay $2,000 a month for rent, can your landlord charge you a $100 for paying a day late? How about a $1,000? What about a million bucks?! Crazy, right? But is it legal?

Disclaimer: The following information does NOT constitute legal advice and is only for general educational purposes. Each situation is different and specific legal issues usually require additional research and investigation, so do not rely on this article to address a particular legal issue; use it as a starting point to gain a general understanding.

1. A Brief History of Usury

In New York, the legal definition of usury is the corrupt agreement of parties by which more than lawful interest is paid, or is to be paid, as compensation for a loan or for forbearance in collecting money advanced as a loan.[1] Interestingly, usury has been banned or regulated since Biblical times,[2] and again by the Babylonians, Greeks, Romans and throughout Medieval Europe.[3] Today, many envision the classic loan shark, brutally enforcing punitive rates against some unfortunate who, down on their luck or desperate for cash, has nowhere else to turn.[4]

Indeed, the original purpose of usury laws in New York State was to protect poor people from the consequences of their own desperation.[5] Current usury laws protect not only against extortionist practices from organized crime, but also by banks, credit cards, and similar lenders (such as those making “pay day” loans), although many of these monied sources are exempt from the laws of New York State due to federal pre-emption.[6] However, an aspect of usury laws overlooked by many is the question of whether they apply to “penalty” and “late fee” provisions in contracts or commercial leases.

2. New York: Civil vs. Criminal Law

Before we discuss usury and its application to “penalty” provisions, let’s have a quick look at the difference between “civil offenses” and “crimes,” which to the layperson, and even many lawyers, is sometimes confusing. Generally, speaking, “criminal law” involves prosecution by the government of a person for an act or omission of conduct that has been classified as a “crime” by the federal, state or local government, and can result not only in fines but also imprisonment - the person, if found “guilty,” is “convicted” of a “crime.”[7]

By contrast, “civil” cases usually are initiated by other private parties, or by government agencies which may or may not have the function to prosecute crimes (for example the U.S. Environmental Protection Agency or the N.Y.C. Landmarks Preservation Commission). When a court or administrative body rules for the “Plaintiff” (the party suing), the Defendant (the party being sued) usually has to pay a fine, but ordinarily does not go to jail, nor is the Defendant guilty of a crime.[8]

In New York, a “crime” is defined as either a “felony” or a “misdemeanor” so any penalty that isn’t one of those usually is not considered a “crime.”[9] However, be aware, that even a “violation” which technically is not a “crime,” theoretically could carry a prison sentence of up to 15 days.[10] Also, as with everything, there are exceptions, and sometimes government agencies normally charged with enforcing everyday regulations that carry civil fines actually are able to seek criminal penalties for egregious conduct.[11]

3. Usury as Both a Civil Offense and a Crime

Ok, we got our legal history and general law knowledge out of the way. What about usury, specifically? Well … the usury laws in New York are Byzantine to say the very least.[12] We start with New York General Obligations Law §5-501[13], which fixes the maximum rate of interest for loans and forbearances of repayments at 6% per year - unless, the New York Banking Law, §14a says differently - which it does, setting the maximum annual rate at 16% per year.

Charging more than this legal rate of interest could result in the entire loan being invalidated. If that happens, this means the lender cannot recover the excess interest, or even the proper interest, or possibly even the original loan! That’s right. You read that correctly. A person or entity lending money at usurious rates risks losing the entire loan as well as both the legal and/or excessive interest.[14]

Even more fun, if someone charges more than 25% per year, they could be guilty of criminal usury, which is punishable either as a class E or C felony, depending on circumstances,[15] carrying a prison sentence of up to four or fifteen years, respectively.[16] The bottom line: Charge more than 16% per year and you can suffer some heavy financial penalties; charge more than 25% per year and you can go to jail for a long time.

4. Exceptions and Exemptions

Then, there is a laundry list of exceptions. Loans of $250,000 or more are exempt from the civil penalty but not the criminal penalty.[17] Loans of $2.5M or more are exempt from both penalties.[18] Corporations may not use the usury defense against civil usury (16%) because corporations are the “antithesis of poor people,” and therefore not the protected class for whom the usury law was enacted;[19] nevertheless, even corporations may use an usury defense against criminal usury (25%) (to prevent loan sharking to companies), but remember loans in excess of $2.5M cannot be usurious at all.[20]

However, if the corporation is really only a shell meant to facilitate the loan to an individual, then the corporation and/or the individual actually may be able to assert the usury defense provided the loan is less than $2.5M.[21] Confused, yet? There are more exemptions for loans backed by homes and co-ops, etc. and distinguishing those loans made by certain federal entities.[22] Also, an entity based in another state is entitled to charge the interest permitted by that state to its New York customers (for instance a credit card based in South Dakota, governed by Delaware law, used by a New York resident).[23]

5. Usury Applied to Late Fees

Ok, so there are plenty of exceptions and carve-outs, but the general rule is you can’t charge someone more than 16% per year for a loan, and if you charge more than 25% you’re going to the big house, hooscow, pokey, slammer, etc. So, back to our original question. What can you charge in the way of penalties, say for a late payment on a commercial lease or late delivery of goods, contractually? Are penalties governed by usury laws?

As with anything else in law, it’s a bit gray and fact specific, so again, please don’t rely purely on this article. However, some cases are illustrative. First off, it’s important to determine if New York law even applies. Generally, a court will look to the plain language of a contract’s choice of law provision to determine which State’s laws to apply.[24] In other words, if the contract says it will be governed by the laws of Kalamazoo, as long as the laws of Kalamazoo have a “reasonable relationship” to the transaction or parties at stake, New York courts usually will enforce the choice of law.[25] So for example, in Ideas v. 999 Restaurant Corp, the contract in question said it should be governed by Illinois law which permitted a higher interest than New York, but as the “lender” was a New York company and the “borrower” was a New York company, and the transaction was conducted in New York not Illinois, the court found that New York usury laws would govern, not the usury law of Illinois.[26]

The next question is whether the contract is really a “loan” or a “forbearance” (and thereby subject to usury laws). Courts have held the following transactions not to be a “loan” or “forbearance” and therefore not subject to usury laws: municipal water late charges of 10% per month (120% per year),[27] private parties applying 2% per month late fees (24% per year),[28] and private parties applying a 1.5% per month contract service charges (18% per year).[29] In addition, New York courts have held that even if a particular transaction fell under usury limits that penalties and interest could not be added together in determining total “interest” as limited by usury.[30]

So, it appears that most contractual relationships, governed by late fee penalties and interest payments for tardy payments, are NOT covered by New York’s usury laws. However, sometimes, courts do find exceptions, such as a "vendor advance payment" which could be construed as a “loan” or “forbearance.”[31] For example, in Ideas v. 999 Restaurant Corp, where Clever Ideas offered an “advance meal sales” agreement to 999 Restaurant, i.e. $213,000 in credit that had to be used to purchase $319,000 in food inventory (arguably 49% interest) from Clever Ideas, that agreement was held to be "loan" and potentially usurious.[32]

Also, if a penalty or late fee is “confiscatory” it might be voided by the court as usurious, even if the underlying transaction technically is not a loan or forbearance.[33] In one dispute between a condominium board and a unit owner, the condo board charged a late fee of either 4% for every dollar owed or up to $800 at the condo board’s discretion; since the owner’s monthly maintenance was about $1,300, the $800 penalty was the equivalent of nearly 60% annual interest (although it was a one time fee).[34] The court ruled that the penalty was not a loan, and therefore not normally subject to usury laws; however, because the penalty was so high in proportion to the amount due, the court found the penalty to be “confiscatory” and a violation of “public policy” as illustrated by New York’s regard for interest of over 25% as "criminal" in nature.[35] As such, the court, struck down the higher penalty fees, but reinstated the 4% fee which it found reasonable.[36]


As usual, there are no hard and fast rules here, but it would seem that a penalty or late fee is not typically regarded as a loan and therefore could exceed the equivalent of 16% interest per year, at least under some circumstances. However, courts could be reluctant to enforce “confiscatory” penalties, which likely would be calculated as something worth over 25% per year interest. Any charge that high potentially could have criminal implications, and since some transactions could be considered loans or forbearances even though they do not appear to be so at first blush (like the advance meal sales agreements), caution is well advised in drafting any penalty or late charge clause.

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[4] Hammelburger v. Foursome Inn Corp., 54 NY2d 580 (1981) (discussing the NYS Commission on Investigation 1965 report on “loan sharking” and the need for a criminal penalties for usury and cracking down on the related violence associated with “loan sharking”); Schneider v. Phelps, 41 N.Y.2d 238 (1977) (i.e. corporate exemptions could be used by loan sharks to take advantage of ordinary individuals);

[11] Examples: The U.S. Environmental Protection Agency, the NYS Attorney General, in anti-trust actions, and the NYC Landmarks Preservation Commission can all seek either civil or criminal penalties depending on the action and circumstances.;;

[12] (especially, see the flow chart at the end of the article - while I cannot vouch for the legal work of another firm, it appears as if they could be a great resource to gain an introductory understanding of NYS’s very complicated usury scheme).

[14] Freitas V. Geddes Savings And Loan Association, 481 N.Y.S.2d 665, 671 (1984) (citing another case about usury, the court noted that, “Plaintiff contended that this omission was an illegal departure from the statutory command that the statement of the loan should clearly and distinctly show the date of maturity, and in view of the technical error, the note and chattel mortgage given to defendant to secure a loan should be declared void. In response to plaintiff's contention, this court noted that violation of the act deprived the lender of all right to collect or receive any principal, interest or charges, and exposed the lender to the possibility of a misdemeanor charge."

[15] N.Y. Penal Law, §190.40 and §190.42.

[19] Funding Group v. Water Chef, 19 Misc.3d 483, 487 (N.Y. Supreme Court 2008) (“While pursuant to General Obligations Law, § 5-521 (1) corporations, generally the antithesis of "desperately poor people," are ordinarily barred from asserting a usury defense.”).

[23] NY Jur, §5 Interest (Law Governing Interest Rates); Chase Bank, USA v. Fisher, 28 Misc. 3d 440 (Dist.Ct. 2010) (Under the guidelines of Interpretive Letter Nos. 776 and 822, issued by the Comptroller of Currency, a national bank with a home office in one state may apply the law of that state where it "conducts virtually all of its credit card operations in and from its main office state." (Comptroller of Currency Interpretive Letter No. 776, at 2 [Apr. 1997]).


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