In a typical case of distressed borrower where the lender was left holding the unpaid debt bag,  the Fifth Circuit Court of Appeals chimed in on the hotly debated and litigated prepayment premiums litigation. In re Denver Merchandise Mart, 740 F.3d 1052 (5th Cir. 2014).  The lender was secured, with the accelerated $24 million note and the alleged prepayment penalty of $1.8 million. Not outrageous considering it was 7.5% of the outstanding principal whereas other courts enforced a 37% prepayment premium in In re School Specialty, 2013 WL 183851, at *2 (Bankr. D. Del. April 22, 2013) So why did the court send the lender home without a prepayment penalty? and 25% in In re Financial Center Associates of East Meadow, L.P., 140 B.R. 829, 839 (Bankr. E.D.N.Y. 1992).

The court’s decision to deny the lender’s claim came down to two reasons:

  1. the borrower did not make any payment before accelerated maturity (here, the borrower and   lender both agreed that no prepayment had actually occurred), and
  2. the note did not say that the lender would be entitled to a prepayment premium in the mere   event of acceleration alone.

And this was the lender’s argument to the court: that the note’s provisions should be read as such, regardless of whether or not the borrower actually made payment prior to the accelerated maturity (also known as prepayment).  The note had some strong language for the lender to argue so: for example, a prepayment premium was supposed to be paid in the event of “Default Prepayment” defined as a prepayment during a default or acceleration under any circumstances and that the prepayment is due whether the prepayment is voluntary or involuntary.  Because prepayment was either mentioned or contemplated in each provision, the court based its conclusion on the plain language of the contract.   

This case of pure contractual interpretation leaves us with a good drafting lesson: the contract will be interpreted against the drafter and if the lender intends to claim a prepayment penalty in the event of mere acceleration, it should say so in the documents.  The court gave an example of another case where the language was sufficient to evidence the lender’s clear intent to charge a prepayment premium in the event of mere acceleration: if “[the lender] accelerates the whole or any part of the principal…[the borrower] waives [its] right to prepay…without premium and agrees to pay a prepayment premium.”  In the court’s view, this sample language was sufficient to deem the prepayment to have been made in the event of mere acceleration for any reason.