No Rescission Without an Illegal Obligation: The Second Circuit Clarifies Section 29(b) in Xeriant, Inc. v. Auctus Fund LLC

Introduction

The United States Court of Appeals for the Second Circuit has delivered a significant opinion on the scope of rescission under § 29(b) of the Securities Exchange Act of 1934. In Xeriant, Inc. v. Auctus Fund LLC, the Court confronted whether a micro-cap issuer (Xeriant) could void a convertible debt financing contract because the lender (Auctus) allegedly operated as an unregistered “dealer” in violation of § 15(a)(1). Judge Chin, writing for the panel, affirmed dismissal of Xeriant’s complaint, holding that:

“Section 29(b) permits rescission only of a contract that requires illegal conduct. Where the agreement can be performed lawfully—here, by repayment in cash or by conversion without any mandatory resale—§ 29(b) provides no private right to unwind the bargain.”

The decision resolves a growing line of district-court and litigant disputes within the Circuit over “toxic” convertible loans, fixes the limitations framework after SEC v. Almagarby and SEC v. Keener in the Eleventh Circuit, and clarifies the private enforcement boundaries of § 29(b).

Summary of the Judgment

• The district court’s Rule 12(b)(6) dismissal was affirmed.
• Even assuming Auctus acted as an unregistered dealer, the Stock Purchase Agreement (SPA) did not compel Auctus to engage in dealer activity (i.e., the purchase and resale of securities).
• Because the contract could be performed lawfully (repayment in cash, or conversion without resale), it was neither “made in violation” of the Exchange Act nor did its “performance involve” a violation.
• Section 29(b) therefore did not authorize rescission; any SEC enforcement remains separate.
• The panel also upheld the district court’s finding that Xeriant’s claim, filed within one year of discovering the alleged violation, was timely—but ultimately irrelevant to the outcome.

Analysis

A. Precedents Cited and Their Influence

1. NexPoint Diversified Real Estate Trust v. Acis Capital Mgmt., L.P., 80 F.4th 413 (2d Cir. 2023)
   Confirmed that under a companion statute (IAA § 215(b)) a contract is void only when performance necessarily violates federal law. The same logic was transplanted to Exchange Act § 29(b).
2. Oxford University Bank v. Lansuppe Feeder, LLC, 933 F.3d 99 (2d Cir. 2019)
   Stated that a “Validity of Contracts” clause in the ICA voids only illegal contracts, not legal contracts tainted by later misconduct. The Court treats that language as a “commonsense” template for § 29(b).
3. SEC v. Almagarby, 92 F.4th 1306 (11th Cir. 2024) & SEC v. Keener, 102 F.4th 1328 (11th Cir. 2024)
   Found that high-volume convertible lenders are “dealers” who must register. Xeriant relied on these decisions to label Auctus’s conduct illegal. The Second Circuit assumed arguendo that those cases applied but distinguished the contractual remedy.
4. Williams v. Binance, 96 F.4th 129 (2d Cir. 2024)
   Established that § 29(b)’s one-year limitations period accrues upon discovery of the wrongful “sale or purchase.” Provided the limitations analysis adopted here.
5. District-court toxic-loan opinions (EMA Financial v. Vystar; DarkPulse v. FirstFire; etc.)—many of which the panel cited—noted the emerging but unsettled trend; the Court now supplies a controlling appellate precedent.

B. The Court’s Legal Reasoning

1. Private Right under § 29(b)

Although § 29(b) states contracts “shall be void,” it does so only within an action brought “within one year” and “within three years” of the violation. The panel reiterated that this text implicitly creates a limited private remedy for rescission but only in circumstances meeting strict statutory conditions.

2. Distinguishing Contract from Conduct

The central doctrinal move was the contract/conduct distinction. A convertible debt agreement might enable unlawful trading, yet:

• Merely issuing a promissory note or warrant is not itself “dealer” conduct.
• The SPA did not require Auctus to convert, still less to resell shares.
• Thus, “there could be lawful performance.” Section 29(b) targets contracts where lawful performance is impossible.

3. Statute of Limitations

Borrowing from Binance, the Court held accrual occurred when Xeriant discovered facts suggesting dealer activity—arguably the June 2023 SEC complaint—making the October 2023 filing timely. The point became moot because the substantive claim failed.

C. Likely Impact on Future Litigation and Practice

• Toxic-Loan Suits Curtailed: Micro-cap issuers seeking to void financing deals face a higher bar; they must plead contract terms that mandate illegal trading, not just allege a lender’s broader business model.
• Forum Selection: Plaintiffs may pivot from private § 29(b) rescission toward SEC whistleblowing or aiding the Commission’s own enforcement actions.
• Contract Drafting: Lenders will emphasize optionality and refrain from covenants that obligate resale; issuers may negotiate express dealer-registration warranties.
• Regulatory Strategy: The SEC’s litigation campaign against unregistered dealers continues unaffected; the Court underscored that § 15(a) is “enforced by the SEC, rather than private parties.”
• Second-Eleventh Circuit Dialogue: While the Eleventh Circuit focuses on defining “dealer,” the Second has drawn the private-remedy perimeter—expect parallel lines of authority to mature.

Complex Concepts Simplified

Section 15(a)(1)

Requires “brokers” and “dealers” to register with the SEC before buying or selling securities for others (broker) or for their own account as part of a business (dealer).

Dealer vs. Investor

A “dealer” buys and sells securities as a business (market-making, inventory turnover). A passive investor trades for investment purposes without providing liquidity to others.

Convertible Promissory Note

A loan instrument that can be converted into equity of the borrower, often at a discount; popular in micro-cap financings.

Toxic / Death-Spiral Financing

Financing structure where the conversion price adjusts downward with the issuer’s market price, encouraging rapid resale and causing share dilution.

Section 29(b)

Allows a private party to void a contract “made” or “performed” in violation of the Exchange Act, but only when the illegal act is embedded in the contract itself.

Rescission

A remedy that unwinds the contract, restoring parties to their pre-contract positions.

Conclusion

Xeriant v. Auctus delivers a clear message: § 29(b) rescission is a precision tool, not a bludgeon. To wield it, a plaintiff must show the four corners of the contract compel conduct that the securities laws forbid. Allegations that a counter-party violates § 15(a) elsewhere, or might exploit conversion rights opportunistically, do not suffice. The opinion harmonizes Second Circuit precedent with common-law illegality doctrines and confines the private remedy to genuinely illegal bargains, while leaving expansive enforcement against “toxic lenders” to the SEC. For practitioners, the case counsels meticulous drafting and a recalibration of litigation strategy in the ever-evolving micro-cap financing arena.