Daily Development for Monday, September 7, 2004
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; EXIT FEES: Provision in short term mortgage loan for “exit fee” payable upon acceleration for any reason, maturity of loan, or prepayment of loan, is valid an enforceable when borrower prepays loan in connection with refinancing.

Delta Rault Engergy 110 Veterans L.L.C. v. GMAC Commercial Mortgage Corp., 2004 U.S. Dist. LEXIS 15136 (E.D. La. 8/4/04)

Borrowers executed a note to GMAC for $8.2 million in short term financing for the purchase of a building. It was anticipated, apparently, that borrowers would shortly be pursuing permanent financing, and apparently also there was some thought that GMAC, the short term lender, would provide it.

The note contained a provision that obligated the borrowers to pay a 1% fee upon the earlier of (a) the date when prepayment of the principal is made, whether in whole or in part; (b) he maturity date; or ( c) the date on which the debt “shall have been accelerated and become immediately due and payable.” The note also stated that the exit fee would be waived if GMAC provided permanent financing for the property in question.

Borrowers refinanced the debt with another lender and were required to prepay the GMAC debt. They paid the $82,000 exit fee, but then sued for its return. The trial court granted summary judgment to GMAC, finding the provision fully enforceable.

The borrowers argued that the fee in question should be treated as a prepayment penalty or stipulated damages, and that in either case, under Louisiana law, there had to be some attempt to relate the fee to the consequences of prepayment to the lender. The federal court here did not dispute the borrowers’ contention that Louisiana law would require some further justification if the fee were regarded as a prepayment penalty or stipulated damages charge, but concluded, instead, that the fee constituted a form of additional loan charge - either a loan fee or deferred interest, depending upon how one wished to regard it. In either case, it was to be analyzed simply on straight contract terms. Was it clear enough to warrant enforcement, and were there any bases upon which borrowers could claim they should not be bound by their promise (such as fraud or unconscionability)?

Borrowers contended that the lender had a duty to negotiate in good faith for a permanent financing, that the it failed to do so. The court noted that the short term loan commitment letter (which borrowers introduced into evidence) stated clearly that there was no agreement to make a permanent loan, and concluded that there was no basis for a claimed duty of good faith and fair dealing regarding the making of such a loan. It noted that lender would have scant incentive to refuse to make a permanent loan of $9 million or so in order to scarf up a measly $82,000 fee.

Comment: The editor does find it interesting that the court did not divide the agreement to pay the fee into three distinct circumstances - maturity, default, and prepayment, and analyze the obligation separately as to each circumstance. Had it done so, presumably, it would have required that the fee meet the conditions for validity that Louisiana state courts apply to prepayment fees of the exit fee were imposed under those circumstances.

By making the fee payable regardless of the circumstances, the lender was able to avoid neatly all the justification tests common law courts have been applying to prepayment penalties.

In a world in which usury laws have little continuing effect and borrowers frequently are willing to sign anything that does not obligate them to pay “up front,” this may be a useful tactic for some lenders interested in getting a little extra revenue at prepayment time.

Comment 2: The case cites DIRT’s own Jack Murray for authority that these fees are common and should not automatically be considered prepayment penalties. It may be that this is one of the first cases coming down squarely in favor of rendering them enforceable as additional loan charges. Since the court cites Jack’s work, but no other justifying authority, one assumes that Jack (who keeps track of every judicial word uttered on the subject) had not yet produced any authority to support the result here, one with which the editor is sure Jack would agree wholeheartedly.

Readers are encouraged to respond to or criticize this posting.

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