A recent case from the U.S. District Court for the Eastern District of New York reminds lenders that, if a loan goes bad, the loan documents can make a big difference in how much the lender eventually recovers.
In U.S. Bank N.A. v. South Side House, LLC1, the borrower defaulted on a fixed-rate mortgage loan. The lender exercised its right to accelerate the due date of the debt and brought a foreclosure action. Before the lender collected any payment as a result of accelerating the debt, the borrower filed for relief under the Bankruptcy Code. In Bankruptcy Court, the lender filed a proof of claim for approximately $31 million of principal and interest, plus an additional $7.5 million as "prepayment consideration." The "prepayment consideration" was an amount provided by the loan documents to protect the lender from losing the benefit of its interest rate, if the borrower prepaid the loan. The borrower objected that the $7.5 million prepayment consideration was not a valid claim in bankruptcy.
The lender's loan documents provided for standard yield protection, or prepayment consideration, if the fixed rate loan was paid before its maturity date. The documents provided that the secured debt included the prepayment consideration (1) if the borrower unilaterally chose to prepay the balance of the loan, or (2) if, after default and acceleration, anyone on the borrower's behalf tendered payment of the loan. The loan documents did not state, however, whether the borrower owed the prepayment consideration if the lender called a default and accelerated the loan, without more; and that was what happened when the borrower filed for bankruptcy.
The court held that a lender generally forfeits the right to a prepayment consideration if the lender accelerates the loan, except where (1) the debtor intentionally defaults in order to trigger acceleration, or (2) the documents clearly and unambiguously call for payment in the event of acceleration. The lender's difficulty in South Side House was that the loan documents did not state that the prepayment consideration became due upon a mere acceleration of the loan without accompanying payment. Therefore, said the court, the lender's claim for approximately $7.5 million was disallowed. Because amounts owing to the lender were secured by a mortgage, disallowance of the claim may have resulted in a substantial loss to the lender.
South Side House reminds lenders, however, that properly drafted loan documents can save lenders a significant amount of money.
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1 No. 11-CV-4135, U.S. District Court, E.D.N.Y., Jan. 24, 2012.