This is the second of a two-part article dealing with yield maintenance fees in the context of Indiana commercial foreclosure law. In Part I, posted under the Court Commentary category, I summarized the only three Indiana cases on point. I’ll now apply that case law and, given the rules, explore some of the decisions commercial lenders may face.
The rules. The law from the Seventh Circuit and the Indiana Court of Appeals is definitive as to a few issues. The general rule is that reasonable prepayment provisions are enforceable. Thus yield maintenance fees (a/k/a prepayment premiums) can be recovered. But there is an exception if a lender accelerates the debt (forecloses). In that instance, the lender waives its claim to yield maintenance fees. In other words, an election to accelerate generally is an exclusive remedy that will preclude the recovery of yield maintenance fees.
Payoff vs. acceleration. Assuming a reasonable yield maintenance fee provision is in the note, a pure payoff by the borrower (an election to prepay the note) generally will permit the assessment of reasonable yield maintenance fees designed primarily to compensate the lender for its lost interest. On the other hand, a pure foreclosure by the lender (an election to accelerate the note payments) probably will defeat a claim for such fees. When lenders hire my firm to foreclose on loan collateral, therefore, we advise that it will be difficult to recover yield maintenance fees. Usually, the lender’s only remedy will be what is articulated in the default/acceleration clause of the note, typically the recovery of the unpaid principal balance, accrued interest, late fees and litigation expenses. Of course, not all cases are the same, and there are exceptions to every rule. As a foreclosing lender, don’t give up on yield maintenance fees until you or your lawyer fully evaluate the issue.
The junior lender’s dilemma. Recently, a lender hired my firm to protect its interests, many but not all of which were subordinate to a senior lender’s. Although our junior lender client was getting paid, the senior lender was not. So, our client got dragged into the senior lender’s foreclosure case. Our note had a yield maintenance provision. Of course the client wanted yield maintenance fees as part of its damages. But, for several reasons, our client’s best interests dictated acceleration and foreclosure, which weakened our argument for those fees. The client understood and relented on its claim.
Decisions like these can be difficult for junior lenders involved in a foreclosure. Typically, the junior lender could choose to declare a default (triggered by the default on the senior debt), accelerate the debt, file a cross-claim against the borrower and reduce its claims to a judgment, as we did in our recent case. There are advantages to this approach, including the creation of a judgment lien. This option, however, almost certainly will result in a waiver of yield maintenance fees. On the other hand, the junior lender could elect to simply answer the complaint, protect its collateral position (priority) in the litigation and await a payoff request when the collateral is disposed of. This scenario likely will result in a recovery of, or a strong argument for, yield maintenance fees. In the final analysis, decisions depend upon an almost infinite number of factors, and there is no case law applicable to every situation. The key is for junior lenders to remain mindful of the general rules and make strategic decisions accordingly.
Demand a calculation. As a competing lender, beware of other lenders improperly building in yield maintenance fees to their judgment amounts. Borrowers and their counsel may not aggressively police the damages claimed by lenders, or they may not know the law. As a party to a foreclosure case, it’s in a lien holder’s best interests to force the plaintiff, and all competing lien holders for that matter, to provide a calculation, based upon admissible evidence, of the nature and extent of the claimed debt. This is particularly true for junior lenders because the amount of a junior lender’s recovery, if any, will increase as the senior lender’s recovery decreases. If a competing lender is not entitled to yield maintenance fees, a timely objection to the claim should be made.
Uncharted waters. Bear in mind that there has been no Indiana case on the topic of yield maintenance fees for over fifteen years, and there are gaps in the law. So creative contract drafting may net positive results. In the commercial setting, courts are disinclined to rewrite contracts and generally will lean toward enforcing what the parties clearly and unambiguously agreed to. For instance, although it may not be a common contract term, it’s conceivable that reasonable yield maintenance fees built into an acceleration clause (to be paid upon foreclosure) could be upheld by an Indiana court. “Reasonable” means, among other things, that the fees are tied to interest formulas in the note or based on present value calculations. Arbitrary or purely penal computations are far less likely to be enforced. As always, I will be keeping an eye out for any new Indiana case law on this issue and will log new posts accordingly.