Daily Development for Tuesday, January 13, 2009
by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Husch Blackwell Sanders
Kansas City, Missouri

MORTGAGES; PREPAYMENT; YIELD MAINTENANCE; AMBIGUITY: Ambiguous computation terms that arguably resulted in a payment greater than “standard” yield maintenance clauses a breach of Deceptive and Unfair Practices Act.

In Sundance Apartments I, Inc. v. General Electric Capital Corp., 581 F.Supp. 2d 1215 (U.S.D.C. S.D. Florida 2008)

Sundance Apartments I, LLC ("Sundance"), brought an action against Lender (the trustee of a commercial mortgage-backed security trust created by the lender) and the servicer, claiming that the yield-maintenance prepayment provision in the loan agreement was "deceptive," forcing Sundance to make a prepayment (under protest) in excess of the actual premium due. The court agreed with Sundance's interpretation of the provision, upholding the borrower's claims of breach of contract and violation of the Florida Deceptive and Unfair Trade Practices Act as valid claims, and denied the lender's and servicer's motions to dismiss.

The yield-maintenance provision in the Loan Agreement entered into between the parties read as follows:

As used herein, "Yield Maintenance Amount" means the sum of the present value on the date of prepayment of each Monthly Interest Shortfall (as hereinafter defined) for the remaining term of the Loan discounted at the Discount Rate.

The Monthly Interest Shortfall is calculated for each monthly payment date and is the product of (A) the prepaid principal balance of the Loan divided by 12, and (B) the positive result, if any, from (1) the yield derived from compounding semi-annually the Loan's Contract Rate minus (2) the Replacement Treasury Rate (as hereinafter defined).

The court summarized the parties' arguments as follows, based on the language in the above prepayment provision:

“Sundance alleges that the term ‘prepaid principal balance’ found in the [yield maintenance] Provision must be read to mean ‘the prepaid balance of the loan for each payment remaining in the term as amortized’ in light of its plain meaning and industry custom. Defendants, however, rejected that interpretation and instead read the term to mean ‘a principal balance fixed at the time of prepayment,’ which allegedly generates a windfall (the "Windfall Interpretation") and permitted Defendants to recover a yield greater than they would have recovered if Sundance had made its regular payments through the maturity of the loan.”
The court ruled that the provision was deceptive and misleading because it "was intended to allow [the lender], or its successor, to charge Sundance a repayment amount that allegedly exceeds the plain meaning and common understanding of the term 'yield maintenance.'"Sundance alleged that it had suffered "actual damages" when it paid the prepayment amount demanded by the lender under protest, and argued that its actual damages should be "calculated as the difference between the alleged correct yield maintenance prepayment amount and the Windfall Interpretation as well as costs, attorney's fees, and other relief.".

Reporter’s Comment 1: This case clearly illustrates the importance of clarity and completeness when drafting yield-maintenance provisions in mortgage-loan documents, as any ambiguity will undoubtedly be construed by a court in the borrower's favor when the lender has drafted the loan documents. Yield maintenance prepayment premiums are generally enforced by state courts (and even most bankruptcy courts) because they are considered commercially reasonable and have become standard in the industry over the past years (and many courts have given "guidelines" as to how these clauses should read in order to be enforceable). Yield-maintenance prepayment provisions have been inserted in commercial mortgage loan documents since the early 1980's, and are familiar to virtually all commercial borrowers.

Reporter’s Comment 2: A prepayment premium clause will only be enforced to the extent permitted by the express contractual language in the loan document itself, and this is the area where most clever borrowers are still able to spot any "opening" to challenge the clause. There is simply no excuse for ambiguity or sloppiness by lenders in drafting these clauses, as the case law has become quite clear as to the language required to ensure enforcement, even where the court (mistakenly) applies a liquidated damages analysis.

The Reporter for this case was Jack Murray of the Chicago office of First American Title Insurance Company. 

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