Express Working Capital, LLC v. Starving Students, Inc.
Docket: Civil Action No. 3:13-cv-3045-O
Court: District Court, N.D. Texas; June 24, 2014; Federal District Court
Defendants’ Motion for Partial Summary Judgment, filed on February 24, 2014, is denied by the Court. Conversely, Plaintiffs’ Amended Motion for Partial Summary Judgment, filed on March 5, 2014, is granted in part and denied in part. The case centers on financing agreements between Plaintiff Express Working Capital, LLC, and Defendants Starving Students, Inc. and Ethan Margalith, executed on various dates in 2012 and 2013. Under these agreements, Defendants sold a portion of their future credit card receivables to Plaintiff for a total of $1,325,000.00, against an agreed value of $1,775,500.00 in receivables. Ethan Margalith signed all agreements for both himself and SSI. The agreements mandated that Defendants' credit card processor, Fortis Payment Systems, would automatically transmit a specified percentage of future credit card receivables to Plaintiff until the full amount owed was paid. Defendants agreed not to change their credit card processor, sell or close their business without notifying Plaintiff, or sell receivables to others. They also committed not to discourage card usage for transactions and affirmed their tax compliance and accuracy of financial information provided. Plaintiff claims that all payments were made, with the last occurring on July 11, 2013.
On July 24, 2013, Defendants stopped remitting payments for purchased receivables to Plaintiff following the last cash advance received from Plaintiff. Defendants claim they made this decision after their attorney advised them that the Agreements in question were illegal. Plaintiff has moved for summary judgment on multiple claims, including breach of contract and fraud, asserting that the Agreements were account purchase transactions rather than usurious loans, and arguing that Defendants breached the Agreements by changing their credit card processor and halting payments. Conversely, Defendants contend that the Agreements are usurious loans and thus unenforceable, seeking summary judgment on their usury defense and counterclaim, arguing these grounds justify a ruling against all of Plaintiff's claims. A hearing was held after the motions were briefed, and the Court deemed the issues ready for determination. The legal standard for summary judgment requires the absence of genuine disputes over material facts, with each party bearing the burden of proof in cross-motions. The primary contention revolves around whether the Agreements are classified as loans or account purchases, which is critical for resolving both Plaintiff's breach of contract claim and Defendants' usury defense and counterclaim.
To establish a breach of contract claim, a plaintiff must demonstrate: 1) the existence of a valid contract; 2) performance or tendered performance by the plaintiff; 3) breach by the defendant; and 4) damages resulting from the breach. Defendants admit to breaching the Agreements but contend they represent usurious loans. The primary contested element of the plaintiff's claim is whether the Agreements constitute a valid contract. Under Texas law, contracts involving interest exceeding the statutory maximum are deemed contrary to public policy, and creditors charging usurious interest face penalties. A usurious transaction is defined as a loan requiring interest above legal limits, with essential elements including a loan of money, an obligation to repay principal, and excess compensation for the use of money. The Texas usury statutes are penal and must be strictly interpreted, with a presumption favoring the existence of a nonusurious contract. Additionally, usury can only arise from a loan or forbearance of money. If parties intend a transaction as a sale of accounts at a discount, it cannot be classified as a loan, and any discounts do not constitute interest. The court must determine whether the Agreements are loans or account purchase transactions; if classified as account purchases, the defendants' usury defense will fail, supporting the plaintiff's breach of contract claim.
A transaction cannot be classified as usurious if it lacks the foundational element of a loan. The Texas Finance Code defines a 'loan' as an advance of money that obligates the borrower to repay the creditor. In contrast, an 'account purchase transaction' involves the sale of accounts at a discount. Distinguishing between these two types of transactions often hinges on the intent of the parties, as evidenced by the contract and surrounding circumstances. Courts assess whether a factoring agreement is a disguised loan based on this intent.
Section 306.108 of the Texas Finance Code states that if the parties label a transaction as an account purchase, it cannot be considered a loan or line of credit. The court must first evaluate the nature of 'Future Receivables,' which are defined as future accounts arising from customer payments through various card types. Defendants contend that because these accounts were not in existence at the time of the agreements, the relevant section does not apply. However, the Finance Code does not stipulate that accounts must exist at the time of the agreement, and the defendants have not substantiated their claim. Case law supports that future receivables can be validly considered accounts in such transactions.
The Texas Business and Commerce Code defines an "account" as a right to payment of a monetary obligation, regardless of whether it has been earned. Black’s Law Dictionary describes an "account" as a detailed statement of debits and credits between parties and an "account receivable" as a balance owed by a debtor for goods or services. An account receivable signifies a right to payment, established when Defendants’ customers use credit or debit cards to purchase goods and services, thus creating future accounts and contract rights for Defendants.
Defendants sold a portion of their rights to payment on these accounts to Plaintiff under agreements labeled as "Future Receivables Sale Agreement." The agreements emphasize that the transaction is a purchase of Future Receivables, not a loan, specifying that no interest or fees are charged, and there are no scheduled payments or fixed repayment terms. This language indicates a mutual intent to engage in account purchase transactions rather than loans.
Defendants contest this characterization, claiming a "form-over-substance" argument and requesting a broader examination of the circumstances. The Court will consider the contractual language and surrounding circumstances to determine intent. The relationship began in May 2011 when Defendants approached Plaintiff for an advance. Notably, Plaintiff did not initiate contact for the initial agreement, and Defendants expressed gratitude for the assistance received. Throughout their relationship, Defendants sold a percentage of future receivables to Plaintiff in arm’s length transactions.
Both parties were represented by legal counsel during negotiations, and Defendants did not claim a lack of understanding regarding the Agreements or their business relationship. Handwritten changes, including the removal of a liquidated damages provision, were made to the Agreements, which Margalith confirmed by initialing each page. Plaintiff accepted several changes proposed by Defendants, and the negotiations included discussions on additional funding. The relationship involved experienced parties engaged in arm’s length transactions, indicating mutual awareness of the Agreements’ substance.
After entering the Agreements, Defendants actively sought further agreements and cash advances. Plaintiff fulfilled its obligations by making payments to Defendants from December 2012 to July 2013, while Defendants performed under the Agreements without objection until July 2013. Over the period from May 2011 to July 2013, the parties entered into ten Agreements, with Defendants fully paying off the first five. Payment ceased only after Defendants were advised by their attorney that the Agreements constituted usurious loans.
There is no evidence suggesting Defendants believed the Agreements were loans or that they were paying interest until they faced financial difficulties. Communications indicate Defendants were aware of the factor rate associated with the Agreements, as noted by their Chief Operating Officer. Defendants have recently experienced financial distress attributed to the high interest rates imposed by Plaintiff.
Until July 2013, both parties treated the Agreements as account purchase transactions, which did not necessitate the payment of usurious interest. Defendants argue that the recourse provisions within the Agreements categorize them as usurious loans, but the central factor is the parties' intent in their financial arrangement. The presence of recourse provisions does not automatically classify the Agreements as loans, as they can vary between contracts. Guidance from the Texas Business and Commerce Code indicates that the intent and characterization of a transaction are paramount, stating that a sale of accounts should not be recharacterized as a secured transaction unless fraud or intentional misrepresentation is present. The Code establishes a 'safe harbor' for parties to designate transfers as sales, ensuring legal certainty that such transactions are treated as sales regardless of recourse terms. The Texas Finance Code similarly prioritizes parties' intent and transaction characterization. The Agreements lack essential loan characteristics, such as specified loan amounts, maturity dates, interest rates, and repayment terms. They explicitly declare that the transactions are not loans, do not incur interest, and lack fixed repayment schedules. Defendants acknowledge that the debt amount remains constant over time and that there is no maturity date.
The Agreements between Plaintiff and Defendants commence upon Plaintiff's payment of the Purchase Price and continue until Plaintiff receives the full Amount Sold. Even without further payments from Defendants over a decade, they remain liable for $1,322,482.71 in 2024, as indicated by Tex. Fin. Code 302.001(c), which governs the interest rate based on the loan's stated term. The Agreements lack scheduled payments or fixed repayment terms, and Defendants’ payments were contingent upon customer purchases made through various payment methods. If Defendants did not create certain 'future accounts and contract rights,' they were not obligated to pay unless they incentivized customers against using those payment methods. The payment amounts varied based on Defendants' business performance. The Court determined the Agreements were intended as account purchase transactions rather than loans, dismissing Defendants’ usury defense and affirming Plaintiff's entitlement to summary judgment for breach of contract.
In addressing claims of fraud and fraudulent inducement, Plaintiff must demonstrate five elements of fraud: a false material representation, knowledge of its falsity, intent for reliance, actual reliance, and resultant injury. Fraudulent inducement specifically requires the existence of a contract. To support its claim, Plaintiff asserts Defendants misrepresented their financial condition, compliance with material contracts, and tax status as part of the Agreements.
Plaintiff alleges that Defendants failed to disclose critical financial issues, including an ongoing lawsuit with their line of credit lender, a change from a line of credit to a promissory note, a damaged relationship with the lender, and federal tax liens on their property. Plaintiff claims reliance on these undisclosed facts when purchasing future receivables, arguing that knowledge of Defendants' true financial situation would have deterred the Agreements. Defendants counter that Plaintiff conducted its own due diligence and regularly funds businesses with prior financial difficulties. The Court identifies genuine factual disputes concerning Plaintiff's reliance, rendering summary judgment on Plaintiff's fraud claims inappropriate.
The Court denies Defendants’ Motion for Partial Summary Judgment but grants Plaintiff’s Amended Motion for Partial Summary Judgment regarding the breach of contract claim, while denying it for remaining claims. Defendants' Motion to Strike evidence is denied as moot since the contested evidence does not affect the outcome. The business relationship involved ten Agreements, five of which were fully paid. The disputed Agreements date from December 2012 to July 2013. Defendants challenge the classification of the Agreements as loans versus account purchase transactions, asserting that the financing arrangements are usurious and thus illegal. The Court references past cases indicating that the true nature of agreements is determined by the intent of the parties, supported by the history of negotiations and contract performance.
Defendants’ expert witness suggested an imputed interest rate, despite the absence of an interest rate in the Agreements, which also lack repayment terms—elements typically found in loan contracts. The expert did not reference the Texas Finance Code section that outlines interest rate determination. The plaintiff's promissory estoppel claim was presented as an alternative in case the Agreements were deemed invalid contracts, as established in relevant case law. If a valid contract exists covering the alleged promise, promissory estoppel cannot be applied, and damages should be sought under the contract instead. Additionally, the plaintiff submitted an amended complaint, including claims for unjust enrichment and alter ego, which were not addressed by the parties, and the Court refrains from commenting on their merits.
