Summary:
In this adversary proceeding arising from a Chapter 11 case, Martinez Quality Painting & Drywall, Inc. (“Debtor”) sought to avoid approximately $799,250 in payments made under two merchant cash advance (“MCA”) agreements with Newco Capital Group VI, LLC (“Newco”), alleging the transfers were constructively and actually fraudulent under § 548 of the Bankruptcy Code, as well as under North Carolina’s Uniform Voidable Transactions Act, and that the MCA contracts were void ab initio under New York’s usury laws.
The agreements at issue involved payments of $575,000 from Newco in exchange for over $799,000 in daily withdrawals from the Debtor’s bank account. While each MCA was labeled as a “purchase of receivables,” the Debtor alleged these were de facto loans with effective interest rates exceeding 40%, thus violating New York’s criminal and civil usury statutes.
Newco moved to dismiss the complaint under Fed. R. Civ. P. 12(b)(1) and 12(b)(6), arguing that the agreements were not loans and that even if they were, they were exempt from usury laws under North Carolina law. Judge Edwards denied the motion as to subject matter jurisdiction and rejected Newco’s argument that the Debtor failed to allege a plausible fraudulent transfer claim. Importantly, the Court declined to engage in a definitive choice-of-law analysis at the pleading stage but assumed, for purposes of the motion, that New York law applied per the MCA contracts’ express choice-of-law provision.
Crucially, the Court distinguished between the application of New York’s civil usury statute (§ 5-511 of the General Obligations Law) and the criminal usury statute (§ 190.40 of the Penal Law). Following precedent in In re Azalea Gynecology (Bankr. E.D.N.C. 2024), the Court held that a corporate debtor like Martinez could not affirmatively invoke the criminal usury statute, as it is only available as a defense. However, the civil usury provision remains a viable basis for alleging the MCA agreements were void, thereby supporting the plausibility of a § 548(a)(1)(B) constructive fraud claim.
The Court emphasized that, under Fourth Circuit precedent (In re Jeffrey Bigelow Design Grp.), the key question in constructive fraud claims is whether the Debtor’s estate received reasonably equivalent value—not whether the agreements were labeled as “loans” or “sales.” Because the Debtor alleged it received $575,000 but paid $799,250, a potential Excess Amount of $224,250 existed that may constitute avoidable transfers.
However, the Court dismissed without leave to amend the Debtor’s claims premised on actual fraud (§ 548(a)(1)(A)), finding no allegations of intent to hinder, delay, or defraud creditors, and likewise rejected a stray reference to preferential transfers under § 547, since the Defendant had been paid in full prepetition and had not filed a proof of claim.
The Court allowed the Debtor’s claims for recovery under § 550 and turnover under § 542 to proceed, and granted leave to amend only the state law claim brought under North Carolina’s UVTA, noting it contradicted the Complaint’s insistence that New York law governed.
Commentary:
In the ongoing judicial reckoning with predatory MCA contracts in bankruptcy, Judge Edwards’ opinion reflects a nuanced and debtor-friendly interpretation of reasonably equivalent value under § 548, while recognizing statutory limits on the application of New York’s criminal usury laws to corporate borrowers. Notably, this decision affirms that civil usury under N.Y. Gen. Oblig. Law § 5-511 remains a viable sword—even if the criminal statute may only be raised defensively.
This case complements and follows the reasoning of In re Azalea Gynecology (E.D.N.C. 2024) but goes one step further by sustaining the debtor’s constructive fraud claim based on a civil usury theory, providing a roadmap for other debtors* and trustees facing similar MCA overreach.
Importantly, Judge Edwards reaffirms that constructive fraudulent transfer claims must focus not on gross repayment totals but on the net effect on the estate—reminding debtors’ counsel to frame avoidance theories in terms of net value lost, not just oppressive terms. The decision further bolsters the viability of challenging MCA schemes in bankruptcy, especially where excessive “fees” and recoupment exceed market equivalents, even without a proof of claim on file.
*That Chapter 13 debtors do not necessarily have the statutory authority to bring these sorts of actions themselves and with Chapter 13 trustee, who will not gain any direct benefit from the time and effort prosecuting this sort of case, might again mean that a debtor should either consider another Chapter, i.e. Chapter 11 where the debtor could bring this action (as was done here) or Chapter 7, where the trustee's own pecuniary interest encourages this sort of action. Alternatively, a Chapter 13 debtor could provide for delegation of this authority in a non-standard provision.
Lastly, as mentioned in the recent post regarding Sliwinski v. Sliwinski, the debtor first commencing an Adversary Proceeding under Rule 7001(3) and then filing a motion under Rule 19(a)(2) to join the Trustee as a necessary and even involuntary plaintiff. The factors for the court to consider include:
(1) the extent to which a judgment rendered in the person's absence might prejudice that person or the existing parties;
(2) the extent to which any prejudice could be lessened or avoided by:
(A) protective provisions in the judgment;
(B) shaping the relief; or
(C) other measures;
(3) whether a judgment rendered in the person's absence would be adequate; and
(4) whether the plaintiff would have an adequate remedy if the action were dismissed for nonjoinder.
With proper attribution, please share this post.
To read a copy of the transcript, please see:
Blog comments