Daily Development forThursday, November 20, 2003 by: Patrick A. Randolph, Jr. Elmer F. Pierson Professor of Law UMKC School of Law Of Counsel: Blackwell Sanders Peper Martin Kansas City, Missouri dirt@umkc.edu MORTGAGES;; PREPAYMENT; PREPAYMENT PREMIUMS; ACCELERATION: The New Jersey Superior Court Appellate Division decided that the state would adopt the view espoused in the Restatement (Third) of Property: a prepayment penalty may be imposed on a mortgagor in default even when the mortgagee accelerates the payment of the debt. Westmark Commercial Mortgage Fund IV v. Teenform Associates, L.P., 2003 WL 21692731 (N.J. Super. Ct. App. Div.) Defendant mortgagor executed a promissory note to the plaintiff mortgagee calling for five years of monthly payments, at which point the balance was due in full. The note was secured by mortgages on three commercial properties in New Jersey. The mortgagor fell behind in its payments and the mortgagee received a final judgment in foreclosure. The mortgagor appealed four amounts due under the note, specifically: late fees, default interest, attorneys fees, and a prepayment penalty. The court found to be reasonable the amounts imposed on the mortgagor with respect to late fees, default interest and attorneys fees. The court corrected a clerical error with regard to the attorneys fees. The court's discussion of the prepayment premium issue, however, is particularly noteworthy. The note in question included a prepayment premium, explaining, in set-off, emphasized language, that the "prepayment premium represents a reasonable and fair estimate of compensation for the loss that holder may sustain from the prepayment of this note. The borrower acknowledges and agrees that it has no right to prepay this note in whole or in part without the prepayment penalty[.]" As the note demanded, the mortgagor acknowledged this language by initialing a space below it. The court noted that New Jersey law does not permit a borrower to prepay a commercial loan absent a document permitting prepayment and that, while the right to impose a prepayment penalty is not unlimited, that penalty serves to protect mortgagees against the loss of a favorable interest yield. The court went on to distinguish the two views on whether a lender may impose a prepayment penalty when the lender accelerates the debt. Citing the Seventh Circuit Court of Appeals in In re LHD Realty Corp., the court explained that one view states that prepayment after a lender accelerates the maturity date is not prepayment but instead is payment made after the maturity. 726 F.2d 327, 330-31. Thus, no prepayment penalty may be imposed. Furthermore, in the case of a lender- accelerated maturity, the lender has established by its act "that it prefers accelerated payment to the opportunity to earn interest over a period[,]" and therefore may not impose a prepayment penalty on this involuntary prepayment. Id. at 331. The court explained that other courts have found to the contrary, allowing lenders to collect prepayment penalties even when those lenders initiate the early payment. The court quoted the Restatement (Third) of Property: "The [mortgagor's early] payment may be 'involuntary' in the sense that the mortgagor would prefer that the debt not be accelerated, but it is still the mortgagor's action in defaulting that triggers the acceleration." Mortgages 6.2 comment c (1997). Citing the deference to parties' agreements shown in Metlife v. Washington Avenue Associates, L.P., 159 N.J. 484 (1999), the court then declared the Restatement more persuasive and held that the sophisticated debtor should not be "relieved of the terms of the contract freely entered into." Not to enforce the penalty, the court said, would be to provide the mortgagor "with a better contract [it] [was] able to negotiate for [itself]." In so holding, the court abrogated Clinton Capital Corp. v. Straeb, 589 A.2d 1363 (N.J. Super. Ct. Ch. Div. 1990), which followed the holding in LHD, supra. Comment: It is difficult to be sure that this really is a holding that prepayment premiums may always be charged on acceleration or whether it is simply a holding that in this case the parties' contract should be interpreted in that way. Readers are encouraged to respond to or criticize this posting. 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