LG Capital Funding, LLC v. Vapor Group, Inc.

Filing 32

OPINION AND ORDER granting in part and denying in part 30 Motion for Partial Summary Judgment. For the reasons stated herein, LG Capital's motion for summary judgment as to breach of contract on Note 2 is GRANTED. Its motion for summary judgment as to breach of contract on Note 1 is DENIED. Given that neither party made a jury demand, the parties are directed to attend a pre-trial conference on 7/9/2018, at which time I will set the date for a bench trial. Ordered by Judge Nina Gershon on 6/27/2018. (Barrett, C)

FILE D

UNITED STATES DISTRICT COURT
EASTERN DISTRICT OF NEW YORK
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LG CAPITAL FUNDING, LLC,
Plaintiff,
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against

IN CLERI(~ OFFiCE .y
E.JD.X1
S
(iS. DIsiR, - Otj'p-

* JUN 28 2018 *
BROOKLYN OFFICE
OPINION AND ORDER
16-cv-03951 (NG)(RER)

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VAPOR GROUP, INC.,
Defendant.
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GERSHON, United States District Judge:
Plaintiff LG Capital Funding, LLC ("LG Capital"), a New York corporation with its
principal place of business in Brooklyn, New York, brings this action against Defendant Vapor
Group, Inc. ("Vapor Group"), a publically traded Florida corporation with its principal place of
business in Miami, Florida. Plaintiff alleges claims for breach of contract and unjust enrichment,
and it seeks costs, expenses, and attorneys' fees. Pursuant to Rule 56 of the Federal Rules of Civil
Procedure, plaintiff now moves for partial summary judgment on its claim for breach of contract.
For the reasons set forth below, plaintiff's motion is granted in part and denied in part.
I.

Facts
Except as otherwise noted, the facts are undisputed for purposes of this motion. On October

8, 2014, LG Capital and Vapor Group entered into a Securities Purchase Agreement ("SPA 1"),
whereby Vapor Group issued to LG Capital a convertible redeemable promissory note with a face
value of $115,500 ("Note 1"), annual interest rate of 8%, and maturation date of October 8, 2015.
Note 1 carried with it a 10% original issue discount such that its purchase price was $105,000. On
October 8, 2014, Dror Svorai, then Chief Executive Officer of Vapor Group, executed a
Disbursement Authorization instructing LG Capital to wire $100,000 to Vapor Group and $5,000
to New Venture Attorneys P.C. for legal services provided in connection with SPA 1 and Note 1.
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On October 14, 2014, LG Capital wired the funds to Vapor Group pursuant to the Disbursement
Authorization, and Vapor Group accepted the $100,000 as satisfaction of Note 1.
On May 11, 2015, LG Capital and Vapor Group entered into a second Securities Purchase
Agreement ("SPA 2"), which provided for the issuance of an 8% convertible redeemable
promissory note ("Note 2") with face value of $35,000 and maturation date of May 11, 2016. That
same day, Svorai executed another Disbursement Authorization instructing LG Capital to wire
$33,250 to Vapor Group and $1,750 to New Venture Attorneys P.C. for legal services provided in
connection with SPA 2 and Note 2. On May 14, 2015, LG Capital wired the funds pursuant to the
Disbursement Authorization, and Vapor Group accepted the $33,250 as satisfaction of Note 2.
The interest rate on the face of each note is 8%. (Ex. D. to Lerman Deci. at 1; Ex. H to
Lerman Decl. at 1). Notes 1 and 2 also both provide for various Events of Default, and both state
that "[u]pon an Event of Default, interest shall accrue at a default interest rate of 24% per annum,
or if such rate is usurious or not permitted by current law, then at the highest rate of interest
permitted by law." (Ex. D. to Lerman Dccl. at 5; Ex. H. to Lerman Decl. at 5). Thus, upon the
occurrence of an Event of Default, the 8% interest rate jumps to 24%.
Notes 1 and 2 also provide LG Capital with an option to convert portions of each Note's
principal face amount and accrued interest into shares of Vapor Group common stock. Pursuant to
this option, on April 21, 2015, LG Capital converted $8,000 of principal and $331 of accrued
interest on Note 1 into Vapor Group common stock, leaving a principal balance of $107,500 on
Note 1. On May 4, 2015, it again exercised its conversion rights under Note 1, converting $17,500
of principal and $774.79 of accrued interest into Vapor Group common stock. LG Capital claims
that this leaves a balance of $90,000 on Note 1, but Vapor Group disputes this figure to the extent
it does not account for the undisbursed 10% issue discount. That is, Vapor Group argues that the

balance on Note 1 following the conversions to common stock is actually less than $90,000
because the original loan paid out under Note 1 was subject to the 10% original issue discount so
that it was 10% (or $10,500) less than Note l's original face value, which was $115,500.
On May 21, 2015, Vapor Group became delinquent in its filing with the Securities and
Exchange Commission ("SEC") for its failure to file a Quarterly Report; this constituted an Event
of Default under Note 1. Default interest of 24% thus began to accrue on May 21, 2015 on Note
1, and default interest began to accrue on Note 2 by virtue of a cross-default provision in Note 1.
On October 8, 2015, Note 1 reached maturity and became due and payable. On May 11, 2016,
Note 2 reached maturity and became due and payable. Apart from the conversion of the principal
value and accrued interest of Note 1 to common stock as discussed above, Vapor Group has not
made any payment to LG Capital under either Notes 1 or 2 as of the date of the filing of the papers
for this motion.
II.

Summary Judgment Standard
A party is entitled to summary judgment if "there is no genuine dispute as to any material

fact and the movant is entitled to judgment as a matter of law." Fed. R. Civ. P. 56(a); Celotex

Corp. v. Catrett, 477 U.S. 317, 322 (1986). Only disputes relating to material facts—i.e., "facts
that might affect the outcome of the suit under the governing law"—will properly preclude the
entry of summary judgment. Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 248 (1986). An issue
of fact is "genuine" if "the evidence is such that a reasonable jury could return a verdict for the
nonmoving party." Id.
The moving party bears the burden of demonstrating "the absence of a genuine issue of
material fact." Celotex, 477 U.S. at 323. Once the moving party has asserted facts showing that
the non-movant's claims cannot be sustained, the nonmoving party must "come forward with

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specific facts showing that there is a genuine issue for trial." Matsushita Electric Ind Co., LTD.

v. Zenith Radio Corp., 475 U.S. 574, 587 (1986) (internal quotation marks omitted).
In determining whether to grant summary judgment, the court must "construe all evidence
in the light most favorable to the nonmoving party, drawing all inferences and resolving all
ambiguities in its favor." Dickerson v. Napolitano, 604 F.3d 732, 740 (2d Cir. 2010). However,
the mere existence of a scintilla of evidence in support of the non-moving party's position will be
insufficient; there must be evidence on which the jury could reasonably find for the non-moving
party. Anderson, 477 U.S. at 252.
III.

Discussion

A.

Breach of Contract
Plaintiff now moves for summary judgment on its breach of contract claim. To establish a

claim for breach of contract under New York law, a plaintiff must show: (1) the existence of an
agreement, (2) adequate performance of the contract by the plaintiff, (3) breach of contract by the
defendant, and (4) damages. Eternity Glob. Master Fund Ltd. v. Morgan Guar. Tr. Co. of N Y.,
375 F.3d 168, 177 (2d Cir. 2004).
Here, Vapor Group does not dispute that all elements are met, including that it breached
the terms of Notes 1 and 2. Rather, Vapor Group invokes the affirmative defense of criminal usury
and argues that the 10% issue discount on Note 1 is functionally hidden interest, which, when
combined with the 24% default interest, spikes the effective interest rate above the legal limit of
25%, in violation of New York's criminal usury statute, N.Y. Penal Law § 190.40.'

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N.Y. Penal Law § 190.40 provides: "A person is guilty of criminal usury in the second degree
when, not being authorized or permitted by law to do so, he knowingly charges, takes or receives
any money or other property as interest on the loan or forbearance of any money or other
property, at a rate exceeding twenty-five per centum per annum or the equivalent rate for a
longer or shorter period."
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Vapor Group does not, and cannot, assert a criminal usury defense as to Note 2 because it
did not carry the 10% issue discount. And, as mentioned, on May 21, 2015, Vapor Group defaulted
on Note 2 by virtue of its failure to timely file a Quarterly Report with the SEC under Note 1 and
Note I's cross-default provision. Plaintiff's motion for summary judgment as to defendant's
liability under Note 2 is therefore granted. LG Capital is entitled to a total of $53,953.88 in
damages. This consists of Note 2's face value ($35 000)2 seven days of 8% interest (from the date
of Note 2's funding on May 14, 2015 to Vapor Group's default on May 21, 2015) amounting to
$53.70; and, as requested by plaintiff, 820 days of 24% interest (from May 22, 2015 to the date of
filing of this motion on August 18, 2017), amounting to $18,900.19.
As to Note 1, Vapor Group is correct that New York's criminal usury statute defines an
interest rate of 25% or more as criminally usurious. See N.Y. Penal Law § 190.40. The parties
dispute, however, whether the criminal usury law applies to default interest rates. In Manfra,

Tordella & Brookes, Inc. v. Bunge, the Second Circuit stated, in dictum and in the context of a
discussion about New York's civil usury laws, that New York "usury laws do not apply to
defaulted obligations." 794 F.2d 61, 63 n.3 (2d. Cir. 1986) (emphasis added). Several district courts
have since concluded that the criminal usury law, like the civil usury law, does not apply to default
interest rates. See Roswell Capital Partners LLC v. Alternative Const. Techs., 2009 WL 222348,
at *15_*16 (S.D.N.Y. Jan. 30, 2009); Sabella v. Scantek Med. Inc., 2009 WL 3233703, at *17
(S.D.N.Y. Sept. 25, 2009); Hillair Capital Investments, L.P. v. Integrated Freight Corp., 963 F.

New York's civil usury statute, by contrast, prohibits charging interest on a "loan or
forbearance" at a rate above 16% annually. See N.Y. Gen. Oblig. Law § 5-501(1)—(2); N.Y.
Banking Law § 14—a(1). Because Vapor Group is a corporation, it cannot assert a civil usury
defense. N.Y. Gen. Oblig. Law § 5-521(1).
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Because the parties do not dispute that $1,750 was used to reimburse attorneys associated with
the issuance of Note 2, this fee is not hidden interest and Vapor Group is liable for it. Hillair
Capital Investments, L.P., 963 F. Supp.2d 336, 339 (S.D.N.Y. 2013).
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Supp.2d 336, 340 (S.D.N.Y. 2013); Beaufort Capital Partners LLC v. Oxysure Sys., Inc., 2017
WL 913791, at *3 (S.D.N.Y. Mar. 7, 2017).
However, in a recent decision, Judge Cathy Seibel engaged in a comprehensive analysis of
state and federal cases and convincingly determined that the New York Court of Appeals "would
hold that the criminal usury cap limits interest charged on debts to 25% annually, even for
defaulted debts." Madden v. Midland Funding, LLC, 237 F. Supp. 3d 130, 144 (S.D.N.Y. 2017);

accord Union Capital LLC v. Vape Holdings Inc., 2017 WL 1406278, at *8 (S.D.N.Y. Mar. 31,
2017). I find Judge Seibel's reasoning persuasive and conclude that the state criminal usury cap
applies to default interest rates.
This, however, does not end the inquiry. Vapor Group's usury defense requires a finding
that the 10% issue discount on Note 1—amounting to $10,500—is hidden interest, rather than a
reasonable fee attendant to the loan. Borrowers may pay expenses attendant on a loan without
rendering the loan usurious. Lloyd Capital Corp. v. Pat Henchar, Inc., 80 N.Y.2d 124, 127 (1992).
However, when fee payments do not actually reimburse lenders for expenses associated with the
loan, and instead are disguised loan payments, such fee expenses are considered in determining
the interest rate. Hillair Capital Investments, L.P., 963 F. Supp. 2d at 339; see Lloyd Capital Corp.,
80 N.Y.2d at 127. The question of the purpose of a fee payment is an issue of fact. See Lloyd

Capital Corp., 80 N.Y.2d at 127 ("[borrowers] made no showing that fees charged in this case
were a pretext for higher interest, so as to create a triable issue of fact.").
Plaintiff argues that this issue need not be tried because the 10% issue discount, even if
considered hidden interest, brings the total interest rate to 18.8%, well below the legal limit.
However, the calculation used by LG Capital to reach the 18.8% interest rate does not account for

the 24% default interest. 3 It simply combines the 8% pre-default interest rate with the 10% issue
discount and concludes that the composite interest rate is 18.8% percent and thus below the cap.
But such analysis misses the point of Vapor Group's argument—that it is the 10% issue discount
combined with the 24% default rate that renders Note 1 criminally usurious. LG Capital does not
account for the latter interest rate. Since the nature of the issue discount is a question of fact, LG
Capital's motion for summary judgment as to Note 1 must be denied.
B.

Remedy if Interest Rate Found to be Usurious
Although a finding of usury awaits a factual decision, the parties have briefed the issue of

remedies. Specifically, Vapor Group argues that summary judgment should be denied because
there is a dispute of material fact as to the remedy for a criminally usurious note. Def. Mem. of
Law at 4-5. This is incorrect. Remedies are an issue of law, not of fact, and therefore not a
barrier to summary judgment. I thus address the issue of remedies in the event that a finding of
usury is made.
In In re Venture Mortg. Fund, L.P. v. Schmutz, the Second Circuit stated that it is an open
question under New York law whether a loan is void if it violates New York's criminal usury
statute without violating the civil usury statute, or whether a district court should apply a nonusurious interest rate or cancel the interest obligation but not the obligation to pay the principal.
282 F.3d 185, 189 (2d. Cir. 2002). The Court also noted the "harsh" consequences to a lender of
voiding a usurious loan transaction: "the borrower is relieved of all further payment—not only

LG Capital did the following arithmetic to support its argument: first, it identified the total
amount due under Note 1 by multiplying $115,500 (the principal amount due) by 1.08 (the predefault interest rate) to get $124,740. Then, it subtracted $105,000 from $124,740 ($124,740$ 105,000) to get $19,740, thereby identifying the dollar value of the 10% issue discount as
applied to the total amount due. Finally, it divided $19,740 by $105,000, the purchase price of
the loan, resulting in an 18.8% interest rate. Def's Mem. of Law at 16.
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interest but also outstanding principal... [i]n effect, the borrower can simply keep the borrowed
funds and walk away from the agreement." Id. at 189. Following In re Ventures, courts have
declined to void usurious loans, preferring the alternatives offered by the Second Circuit. See

e.g., Profi Merch. Advance Capital, LLC v. C Care Servs., LLC, 2015 WL 4392081, at *5 n. 4
(S.D.N.Y. July 15, 2015) (stating that, if the agreement at issue were found to be usurious, the
court would set a non-usurious interest rate rather than voiding the agreement.); In re BHSutton

Mezz LLC, 2016 WL 8352445, at *38 (Bankr. S.D.N.Y. Dec. 1, 2016) (relying on In re Ventures
and revising the interest obligation to a non-usurious rate); see also Carlone v. Lion & the Bull

Films, Inc., 861 F.Supp.2d 312, 323 (S.D.N.Y 2012) (reasoning that voiding could lead to
"unjust results" and holding that the "better approach, at least in these circumstances, is to void
only the usurious interest rate.").
Here, Note 1 expressly accounts for the possibility of a usurious note: "Upon an Event of
Default, interest shall accrue at a default interest rate of 24% per annum or, if such rate is
usurious or not permitted by current law, then at the highest rate of interest permitted by law."
(Ex. D. to Lerman Deci. at 5). I find no reason not to abide by the terms of an agreement entered
into by two sophisticated parties, especially when the alternative—to void Note 1— would cause
precisely the kind of "harsh" circumstances against which the In re Ventures Court cautioned.
Should the interest rate be found usurious, the rate will be revised to a non-usurious rate.
C.

Costs and Attorneys' Fees
LG Capital also seeks costs, expenses, and attorneys' fees. When a contract provides that

in the event of litigation the losing party will pay the attorneys' fees of the prevailing party, the
court will order the losing party to pay whatever amounts have been expended by the prevailing
party, so long as those amounts are not unreasonable. Diamond D Enterprises USA, Inc. v.

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Steinsvaag, 979 F.2d 14, 19 (2d Cir. 1992) (internal quotations omitted). Here, both Notes 1 and
2 unambiguously provide that LG Capital is entitled to costs and attorneys' fees if it prevails in
litigation related to the Notes. (Ex. D. to Lerman Dccl. at 4; Ex. H. to Lerman Dccl. at 4).
Following trial, LG Capital will have an opportunity to seek costs, including attorneys' fees, on
Note 2, and, if successful at trial, on Note 1.
D.

Conclusion
For the foregoing reasons, LG Capital's motion for summary judgment as to breach of

contract on Note 2 is GRANTED. Its motion for summary judgment as to breach of contract on
Note 1 is DENIED. Given that neither party made a jury demand, the parties are directed to attend
a pre-trial conference on July 9, 2018, at which time I will set the date for a bench trial. Parties
should review my Individual Rules and be prepared to orally discuss the evidence they intend to
offer at trial. Individual Rules § 4A.
Since there are still issues to be decided, the Clerk of Court is directed to refrain from
entering judgment until the case is fully resolved.

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[III) 0 4 0 3

1 I Ii

Nina Gershon

/s/
NINA GERSHON
United States District Judge

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June 27, 2018
Brooklyn, New York