Daily Development for Wednesday, August 16, 2006
by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri

MORTGAGES; PREPAYMENT; “LOCK OUT:” A lock-out clause that prohibits prepayment without the lender's consent, may not be enforceable.

 Littlejohn v. Parrish, 839 N.E.2d 49 (Ohio Ct.App. 2005)

The mortgage in question was held by an individual mortgagee, not an institution, and the mortgagee insisted on language that stated that the mortgage could not be prepaid without the mortgagee’s consent.  Note that if the mortgagee had been well advised, it might have left the instrument alone, since in most states, including Ohio, the “perfect tender in time” rule is that a note cannot be prepaid unless the document expressly provides for prepayment rights. 

The trial judge held that the lenders under this language had the right to refuse prepayment.  Note that the note was high, at 9 %, and still had three years to run.  The mortgagee had refused a cash premium in an undisclosed amount to accept prepayment.   On the other hand, the mortgagee had permitted the borrowers to substitute security a number of times.

In reversing the trial court, the Ohio Court of Appeals  made a number of analytic leaps to conclude that the borrower ought to have the right of reasonable prepayment.  In doing so, it upset a number of other apple carts that ought to give Ohio lawyers fits.  Ironically, in the end it remanded with a comment that it doubted that

The court held that ever contract in Ohio contains an implied covenant of good faith and fair dealing, even mortgage contracts (although it declined to conclude that such duty would sound in tort.)  Under this duty, the mortgagees here  had a obligation to consider the requests for prepayment, and to accept them if they were accompanied by a reasonable offer of a fee to represent the lenders' damages. The court noted:

“[A]nything involving only money can be reduced to present value. That is, a nine percent interest rate on the remaining balance payable over the remaining period can be valued and used to pay off the loan reasonably. If this was offered and refused, then the [lenders] were not dealing fairly, and their refusal to release the loan would have been an unreasonable restraint on alienation. If the [borrowers] simply insisted on paying off the loan without accounting for the now generous interest rate, then their actions were unreasonable. The trier of fact should be able to figure this out.”

As indicated, the court record does not show whether a proper premium had ever been offered, and thus the case was remanded.

The court, however spent a good part of the opinion dwelling on the question of whether there ought to be an analogy between the prepayment situation and the question of whether a landlord has an implied duty of good faith to consent to an assignment or sublease under a clause giving the landlord the right to withhold consent, but not stating that consent can be arbitrarily withheld.  The court acknowledged that a 2-1 Ohio appeals court decision about 20 years ago upheld the landlord’s right in such cases, but opined here that it thought the dissenter correct when he argued that the Restatement rule ought to apply, which requires the landlord to be reasonable except when a “freely negotiated” provision in the lease gives the landlord the right to be arbitrary. 

Comment 1: The editor is not certain that the universal rule is that lenders owe to borrowers a duty of good faith and fair dealing in financial papers.  But he believes that the general recognition of such a duty likely is consistent with developing precedent.

Comment 2: According to mortgage law maven Dale Whitman, this case is “an extremely unusual holding” . . . “a rare case.”  Keep in mind, however, that part of what makes it rare is the amateur language of the prepayment language.  An institutional prepayment clause would give the borrower the right to prepay only upon payment of a premium, or else it would deny prepayment entirely.  There is no reason for the lender to reserve discretion.  Of course, the lender has discretion even if the note doesn’t say so, but such unstated discretion typically does not give rise to a duty of good faith.  For a post-Littlejohn case upholding this principle, but otherwise unrelated to the facts here, see Diamond Triumph Auto Glass v. Safelite Auto Glass Corp., 2006 Westlaw 2129493 (M.D. Penn. 7/31/06) (applying Pennsylvania and Ohio law and limiting the reach of Littlejohn). 

Comment 3: In the area of lease assignments, however, courts around the country have recognized that the very well established precedent has been that landlords do have the right to be unreasonable in refusing to consent when they have a right to consent to assignments or sublets.  The court’s assertion in this case that the law is trending the other way is a myth propounded by thoughtless law professors who would like the law to be as they want it, rather than as it is.  Because of this sloppiness, the editor believes that ultimately landlords will lose the battle here.  Most likely this simply will require much clearer language protecting the landlord’s discretion (and that’s not such a bad thing.).  But for an analysis of the “non trend” see the editor’s piece on the DIRT website, which notes that there have been just as many recent cases denying the duty of good faith in the lease assignment situation as there are finding that such a duty exists. https://e2k.exchange.umkc.edu/exchweb/bin/redir.asp?URL=http://dirt.umkc.edu/files.htm

#pat  The piece is twelve years old, but the editor has been watching the case law, and writing about it in Friedman on Leases.  There hasn’t been much change.  

Readers are encouraged to respond to or criticize this posting.

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