Prepayment Premium Language: A Trap for the Unwary Lender
A recent Maryland U.S. District Court decision in Key Tidewater Ventures LLC, et al v. PNC Bank highlighted some of the pitfalls a lender faces when modifying loan documents. Subsequent to entering into a loan modification agreement with borrowers, a lender had difficulty enforcing a prepayment provision. Key Tidewater Ventures LLC and its affiliates obtained three loans from a predecessor of PNC Bank. The three loans were eventually consolidated into a consolidated promissory note, which went into default. Significantly, the consolidated promissory note included the following prepayment provision:
“The Borrower may prepay this Note in whole or in part at any time; however, in the event that the Borrower elects to prepay this Note during the Initial Rate Period or during the first fifteen (15) years of the term following the Initial Rate Period, the Borrower shall pay a prepayment premium ... .Such prepayment premium shall apply if the Borrower refinances the Loan with a lender other than [Defendant] (or its affiliates) or replaces [Defendant] as the lender institution. The above notwithstanding, the prepayment premium shall not apply ... to the extent that a cash flow payment is made ... except as a result of a default and acceleration hereunder, in which case the prepayment premium shall be due.”
After a default under one of the loans, the bank elected not to proceed under the default provisions under the consolidated note, and the parties agreed to refinance the loan “[a]t PNC Bank’s insistence,” which culminated in a forbearance agreement. The forbearance agreement was reached in December 2012 to:
- Re-consolidate the three loans;
- Set new maturity dates; and
- Terminate the relationship between the plaintiffs and defendant upon the loans’ repayment.
The forbearance agreement did not explicitly reference the prepayment premium provision or address its continued relevance. However, the agreement contained two contested provisions. The first preserved the plaintiffs’ existing defaults and established the bank’s obligation to forbear from “exercising and enforcing any rights, remedies, or recourse” associated with those defaults. The second acknowledged that the forbearance agreement did not alter the consolidated note unless expressly stated.
The Prepayment Premium Provision Leaves Much to be Interpreted
The borrowers then repaid two of the three loans and pursued refinance of the third loan prior to the accelerated maturity date in the consolidated promissory note. When the borrowers repaid the third loan, the bank required that the prepayment premium be paid along with the principal and interest due. The borrowers paid the prepayment premium “under protest.” The borrowers then sued the bank under two alternative legal theories: (1) a breach of contract claim, and (2) a claim for unjust enrichment. The bank moved to dismiss the complaint. The District Court denied the bank’s motion to dismiss, allowing the case to move forward on the substantive issues.
Regarding the bank’s first argument, that there was no “breach of contract,” in denying the motion to dismiss the case, the court held that , “... because the contested contracts—the Consolidated Note ... and the Forbearance Agreement ... — do not clearly and unambiguously entitle Defendant to the Prepayment Premium. Key terms in the Prepayment Premium Provision are susceptible to multiple interpretations, and the Forbearance Agreement implies that it modified or perhaps even eliminated the Prepayment Provision. For these reasons, the Court finds the contracts to be ambiguous.”
The court noted: “First, the Prepayment Provision on its own is susceptible to multiple interpretations. Section 5(a) of the Consolidated Note states that the premium is triggered ‘in the event that the Borrower elects to prepay this Note during’ a specified time period before the original maturity date. Neither the Consolidated Note nor the Forbearance Agreement defines the terms prepay or elects... .” The opinion held there were several different interpretations that could have been afforded to the loan documents read as a whole. If the forbearance agreement did not specifically address the prepayment premium language of the original loan documents, the court allowed that the loan documents were susceptible to widely different interpretations and allowed the case to proceed to trial.
Modified Loan Documents Must Address All Provisions
Lenders frequently modify loans and all too often utilize “shelf” loan modification agreements. If a loan modification agreement does not specifically address a provision in the original loan documents — in this instance, whether the bank was entitled to enforce the prepayment premium provision — a borrower may be permitted to contest the enforceability of the prepayment premium.
Significantly, the court’s decision held that:
“ ...the terms of the Forbearance Agreement imply that it modified, if not fully eliminated, the Prepayment Premium Provision from the Consolidated Note. If the Forbearance Agreement truly did not alter the Prepayment Premium Provision, Plaintiffs’ adherence to the new terms would have necessarily triggered the premium. That is to say, the advanced maturity date placed Plaintiffs in the precarious position where they were forced to repay their loans either too early—in relation to the original maturity date, and thus triggering the Prepayment Provision—or too late—in relation to the advanced maturity date, and thus breaching the Forbearance Agreement. A reasonably prudent person could infer that the Forbearance Agreement was intended to alter the terms of Section 5(a) by adjusting the time period in which Plaintiffs would be liable for prepayment, such that Plaintiffs had the opportunity to comply with both the Prepayment Premium Provision and the Forbearance Agreement.”
Although the District Court did not find that the bank was precluded from enforcing the prepayment premium provision, the decision permitted the borrowers to proceed to trial to present extrinsic evidence that may clarify the ambiguous provisions of the loan documents.
Lenders should be aware that any document modifying existing loan documents must address all provisions of the existing documents which conceivably could be affected by the loan modification. Typical provisions that might be affected would be those that impact the maturity date, prepayment premium language, the obligation to make default interest payments, and numerous others. When including a provision in a loan modification agreement that says that a modification agreement “does not alter the original loan documents unless expressly stated,” lenders must carefully review the original loan documents to ensure that there is no need to further amend the modification agreement to address the potential impact of provisions contained in the original loan documents.
Arnie Spevack is a commercial transactions attorney who represents individuals, businesses, lenders and borrowers in financings, closings, negotiations and in the courts. For more information on prepayment premium provisions, contact Arnie at (301) 657-0749 or firstname.lastname@example.org.