In Re Denver Merchandise Mart—Fifth Circuit Emphasizes Need For Clear Contractual Language Regarding Prepayment Premiums

Prepayment premiums have recently been a source of controversy in bankruptcy and appellate courts. One of the latest examples of this trend is the Fifth Circuit's ruling in In re Denver Merchandise Mart, Inc., 740 F.3d 1052 (5th Cir. 2014). The decision in Merchandise Mart stands for the proposition that, in the absence of clear contractual language stating otherwise, a lender's voluntary decision to accelerate a loan generally acts as a waiver of any right to a prepayment premium. The ruling underscores the importance of using unambiguous language in a loan agreement detailing the circumstances under which a borrower is obligated to pay a prepayment premium.

Enforceability of Prepayment Premiums in Bankruptcy

Restrictions on a borrower's ability to prepay secured debt are a common feature of bond indentures and credit agreements. Lenders often incorporate "no-call" provisions to prevent borrowers from refinancing or retiring debt prior to maturity. Alternatively, a loan agreement may allow prepayment at the borrower's option, but only upon payment of a "make-whole premium" (commonly referred to as a "prepayment penalty"). The purpose of these prepayment penalties is to compensate the lender for the loss of the remaining stream of interest payments it would otherwise have received had the borrower paid the debt through maturity.

Bankruptcy courts almost uniformly refuse to enforce no-call provisions against debtors and routinely allow the debtor to repay outstanding debt. Also, courts sometimes disallow a lender's claim for payment of a make-whole premium for breach of a no-call provision because the premium is generally not due under the applicable loan documents during the no-call period. The courts are also divided on the alternative argument sometimes made that a lender should be entitled to contract damages (apart from a make-whole premium) for "dashed expectations" when its outstanding debt has been paid prior to its original maturity. See, e.g., U.S. Bank Trust Nat'l Assoc. v. Am. Airlines, Inc. (In re AMR Corp.), 730 F.3d 88 (2d Cir. 2013) (debtors not required to pay make-whole premium when prepaying secured debt where plain language of loan documents did not require any such payment where default event, a voluntary bankruptcy filing, triggered automatic acceleration of debt); HSBC Bank USA, Nat'l Ass'n v. Calpine Corp., 2010 WL 3835200 (S.D.N.Y. Sept. 15, 2010) (damage claim for breach of no-call provision disallowed under section...