Collecting A Prepayment Premium: Plain Language May Not Be So Plain

Bank of New York Mellon v. GC Merchandise Mart, L.L.C. (In re Denver Merchandise Mart, Inc.), 740 F.3d 1052 (5th Cir. 2014) -

A lender sought to recover a prepayment premium of $1.8 million after acceleration of a note due to the borrower's payment default. After the bankruptcy court and district court disallowed the lender's claim, it appealed to the 5th Circuit.

The note included a provision that stated that if any payment was not paid within 10 days after the due date, the loan, including principal and interest, became immediately due and payable. The note also contained a section on prepayment. During an initial lockout period, the borrower was prohibited from prepaying. After that, the borrower could prepay all (but not less than all) of the principal and interest on the condition that it paid "Prepayment Consideration." The prepayment section also referenced the concept of "Default Prepayment," which meant a prepayment made during a period of default or after an acceleration of the maturity date. In particular:

Borrower shall pay the Prepayment Consideration due hereunder whether the prepayment is voluntary or involuntary (including without limitation in connection with the Lender's acceleration of the unpaid principal balance of the Note) or the Security Instrument is satisfied or reduced by foreclosure (whether by power of sale or judicial proceeding), deed in lieu of foreclosure or by any other means.

The court framed this matter as a question of contract interpretation under state law. Under applicable state law:

A lender may refuse early payment, but may waive this right by contract. If a lender does not waive this right, the borrower may not prepay without paying all future interest as well. However, if a lender does waive its right to refuse prepayment, then it is not entitled to any prepayment penalty unless expressly provided for in the contract. Generally acceleration of a note constitutes a waiver of a prepayment penalty. This is subject to the exception that a court may elect to impose a prepayment penalty if it appears that the borrower defaulted in order to avoid paying the additional interest. The 5th Circuit noted that the prepayment premium was not a remedy for a breach of contract, but rather consideration for the privilege of prepaying. Consequently (1) payment was not subject to a liquidated damages analysis, and (2) thus was...