Indiana Court of Appeals Concludes That Prepayment Premium Enforceable In Foreclosure Case
November 03, 2014
The opinion in Weinreb v. Fannie Mae, 993 N.E.2d 223 (Ind. Ct. App. 2013) is full of Indiana commercial law tidbits, and I intend to write more about the case later this week. Today, I’d like to highlight quickly one of the important, stand-alone holdings by the Court related to “yield maintenance fees” a/k/a “prepayment premiums.” To my knowledge, Weinreb is the first Indiana state court opinion since 1991 commenting on a lender’s right to recover these damages.
Education. For background and context, please click on my 2007 posts: Yield Maintenance Fees, Part I: Indiana Law and Yield Maintenance Fees, Part II: Applying Indiana Law. Weinreb does not change Indiana law. Rather, the case officially extends it. The Weinreb decision for first time upholds prepayment premium damages in a foreclosure (debt acceleration) action, as opposed to a mere pre-maturity payoff scenario.
Recovery of lost interest. The Court in Weinreb first determined that the subject clause constituted a liquidated damages provision. The promissory note stated that, upon a default, the borrower was liable for repayment of “all of the Indebtedness,” which specifically included a recovery of the prepayment premium. (The details of the language used will matter in your particular case.) When a loan is prepaid, the lender is deprived “of interest it was to receive as consideration for making the loan.” It follows that prepayment premiums “insure the lender against the loss of his bargain if interest rates decline.” For a handful of reasons, the Court viewed the subject language as an enforceable liquidated damages clause as opposed to an unenforceable penalty provision.
Amount okay. The defendant guarantor in Weinreb contended that the premium could not be enforced in his case because it was too high. Generally, a lender will need to demonstrate “some proportionality between the loss and the sum established as liquidated damages.” Under the specific facts of Weinreb, which involved a $6MM loan payable over ten years at 6.37%, the 25% of unpaid principle premium was not grossly disproportionate to the lender’s losses, especially considering that the default occurred about two years after closing.
Re-lent at higher rate? The guarantor’s second argument was that the lender could have re-lent at a higher interest rate and thus may not have lost any money as a result of the default. The Court rejected this point. “All that is required is that the prepayment premium be reasonable and bear a relation to [the lender’s] loss.” In Weinreb, the note articulated this idea, and prior Indiana precedent established that such provisions generally are enforceable. The Court held that the prepayment premium fairly compensated the lender for the interest lost.
The Court’s opinion sets out the yield maintenance provision in the Weinreb promissory note. Since the language held up, lenders - both on the front end of transactions and during post-default workout negotiations - might want to compare their clauses to the one in Weinreb.