• Lambert owns “The Free Market” (a
local shopping center)
Prepayment
– Equitable holds a mortgage on The
Free Market, securing repayment of a
$10MM loan (8% interest)
– Loan is payable in full at end of 10-year
term, in a “balloon payment,” in 2020
• 2015: Lambert wants to pay off the
mortgage, tenders Equitable $10MM
• Why would Equitable refuse this
payment? Can they legally do so?
“Perfect Tender in Time” Rule
• In “remedies” terms, the “perfect tender
in time” rules essentially gives the
mortgage lender the right to specific
performance of the borrower’s promise
to repay, in accordance with the terms
of the note
• Does it make sense to give the lender
this right, rather than just an action for
damages?
“Perfect Tender in Time” Rule
• Common law: if the note/mortgage do not expressly
permit prepayment, mortgagee can refuse to allow it,
and insist that borrower repay at agreed-upon time
• Rationale:
– Lender should be able to get the benefit of the investment decision
it made at time Lender made the loan
– E.g., if current interest rates are now below the contracted-for rate,
the lender would suffer a “reinvestment loss” due to prepayment
“Perfect Tender in Time” Rule
• Lender: money damages aren’t an adequate remedy for my
potential reinvestment loss because they aren’t certain to
make me “whole”
– Rationale: lender can’t immediately “cover” (i.e., substitute a new
mortgage loan)
– Real estate is unique, no other mortgaged parcel is a perfect
substitute
– Finding a “comparable” replacement mortgage loan takes a great
deal of time, expense, due diligence
• Restatement of Mortgages § 6.1 rejects the “perfect tender
in time” rule altogether
• Under the Restatement, if a mortgage is silent, the
mortgagor can prepay w/out a fee (i.e., prepayment is not a
breach of the agreement)
– Fannie/Freddie single-family note form allows prepayment w/out a
fee (this has cultivated an incorrect expectation among many
laypersons that mortgage loans can be freely prepaid)
– Lender that wants to restrict the right to prepayment should bear
the burden of imposing a clear contractual restriction
• Only two states (PA and MO) accept this view; the rest still
apply the “perfect tender in time” rule
• Lambert owns “The Free Market”
– Equitable’s mortgage note provides
for an interest rate = 8%
– Note’s prepayment fee = “6% of the
amount prepaid”
• In 2015, Lambert wants to prepay
(balance = $10MM)
– In 2015, prevailing interest rates are
now 10%
• Can Lambert challenge the fee as
an invalid penalty?
Problem 1
Prepayment Clauses
• Mortgage loan documents typically contain one (or more) of
three types of prepayment provisions
– (1) “Lock-out” provision: prepayment is absolutely prohibited, or is
prohibited for a certain period of time
– (2) “Flat fee” (borrower can prepay, but must pay a fee based on a
percentage of the amount prepaid)
– (3) Yield maintenance clause (borrower can prepay, but must pay
a fee based on a formula designed to approximate the lender’s
actual reinvestment loss, by reference to Treasury index rate)
• On these facts, Lambert’s prepayment actually benefits
Equitable!
– Equitable’s interest collected on existing note = $800K/year
– Interest Equitable would earn if it re-loaned $10MM at current 10%
market rate = $1MM/year
– By reinvestment, Equitable would earn an additional $200,000 in
interest per year, each year, for 5 years left on original loan term
– Present value of this benefit to Equitable ≈> $750K!
• Can Equitable collect a $600K prepayment fee when it not
only suffered no loss, but received a ≈$750K benefit?
10-Year, $10MM Loan: What Is Lender’s
Reinvestment Loss Due to Prepayment (for Each
1% Decline in the Interest Rate)?
Prepayment Fees
• Weight of judicial authority: prepayment fee clause is a valid
liquidated damages clause, which can be enforced even if
lender suffered no actual loss due to the prepayment
– Rationale: at time of loan, parties can’t know if rates will go
up/down, or by how much (thus, at time of loan, size of
possible reinvestment loss can’t be determined with certainty)
– Percentage fee is a “reasonable” pre-estimate of damages
due to potential reinvestment loss
Prepayment Fees
• Prof. Whitman has argued that if the
mortgage note contains a prepayment fee,
then the mortgagor effectively has
purchased an “option” to prepay for a price
= agreed fee
– He argues that this fee should thus be
enforceable according to its terms (w/out
regard to “penalty” analysis or evaluation
under “liquidated damages” standards)
•
•
•
•
•
After Loan Year 1:
After Loan Year 2:
After Loan Year 3:
After Loan Year 4:
After Loan Year 5:
$625,000
$574,000
$520,000
$462,000
$399,000
•
•
•
•
After Loan Year 6:
After Loan Year 7:
After Loan Year 8:
After Loan Year 9:
$331,000
$257,000
$178,000
$92,000
Strategery (as George W. Would Say)
• Lambert wants to prepay, but doesn’t want to pay $600K fee, so
he stops making his mortgage payments
• After several months, Equitable declares a default, accelerates
the loan and demands that Lambert pay full $10MM principal
plus accrued interest and $600K prepayment fee
• Lambert tenders full $10MM + accrued interest, but says, “Now
that Equitable accelerated, this is ‘payment,’ not ‘prepayment’ —
so I don’t have to pay the $600K prepayment fee.”
• Is Lambert correct, or not?
• Answer: it depends on the language of the clause
– Equitable’s reinvestment risk is the same, whether the payoff
is voluntary or involuntary (Equitable still has to go out and
reinvest the money)
– If the loan documents expressly allow mortgagee to impose a
prepayment fee if payment occurs following acceleration of the
loan, that fee is enforceable [p. 611, note 6(a)]
– But, if loan documents don’t define payment of accelerated
debt as prepayment, weight of authority treats payment of
accelerated balance as ≠ “prepayment” [p. 611, note 6(a)]
• One critique: yield maintenance clause tied to Treasury
rates “overstates” reinvestment loss
– Treasury (risk-free) rates will always trail real estate mortgage
note interest rates (which account for risk) by 2-4%
– Thus, even if interest rates have not actually increased, yield
maintenance clause will result in prepayment fee
• Defense: Treasury rate is appropriate b/c lender will
reinvest prepaid funds at Treasury rate until it can identify
a suitable replacement investment
Yield Maintenance Clauses
• Parties can’t know future interest rates, but can use a formula
that more precisely calculates the lender’s reinvestment loss
– Note 2, page 606: prepayment fee = present value of all future P&I
payments on the note (discounted at the “reinvestment rate,” which is
based on a Treasury rate), minus the outstanding principal balance due
on the note at the time of the prepayment
• Does this formula accurately reflect the lender’s damages?
• If this formula works, why would the mortgagee choose to use a
“percentage fee” provision instead?
Lopresti v. Wells Fargo Bank (p. 597)
• How is the provision in Lopresti different from a yield
maintenance clause?
– “Breakage Fee” under the clause in Lopresti was based on
the difference between Treasury rate at time of loan and
Treasury rate at time of prepayment
– It thus does not “overcompensate” the lender like a true
yield maintenance clause (p. 606, note 2)
Usury
• Usury laws establish a legal limit on interest rates
• Nominally, Missouri has a 10% usury limit [RSMo. §
408.030]
• Traditional rule: lender can’t enforce usurious interest rate
– Some state laws required disgorgement of all interest collected
– Other states required only disgorgement of any interest collected
above the legal rate
• In the late 1970s, as inflation and interest rates rose, usury
laws threatened the solvency of banks and savings & loan
associations
– 1980: Banks, S&Ls had to pay 14-15% to attract deposits, but
usury laws in most states prohibited them from charging borrowers
more than 10% (or the applicable state law usury limit)
• Potential cost of bailouts prompted federal pre-emption of
state usury laws
– This allowed federally-regulated lenders to make mortgage loans
w/out regard to state law usury limits
Default Interest and Late Fees: Westmark
• Today, due to federal pre-emption and revision of state
usury law in many states, usury law is mostly a “dead letter”
– E.g., federally regulated mortgage lenders are not subject to
state law limits
– E.g., usury rate for payday lenders in Missouri is 1,950%
• In Missouri, parties can agree to any interest rate for:
– (1) A loan to a corporation, partnership, or LLC;
– (2) A business loan of => $5,000;
– (3) Loans secured by real estate, unless the real estate is
residential and the lender is not a federally regulated lender
[Can you spot the usury trap here?]
• Westmark Note: “If the unpaid balance hereof is not
received by Holder on the Maturity Date, or on the
Acceleration Date, such amount shall bear interest at the
Note Rate plus two (2%) per annum (the “Default
Rate”)....” [Default interest]
• Westmark Note: “If any installment under this Note shall
not be received by Holder on the date due, Holder may at
its option impose a late charge of six percent (6%) of the
overdue amount.” [Late fee]
Late Fees and Default Interest
• Suppose that mortgage note has both default
interest and late fee clauses, and that
Borrower is in default (> 20 days has passed
since last installment date w/out payment)
• Lender imposes the default interest rate, and
also assesses a “late fee” on late installment
• Why isn’t that “double counting” by the
Lender (collecting twice for the same harm)?
Late Fees
• By contrast, the late charge or late fee is “backward”looking; it compensates the lender for:
– (1) Administrative expenses and costs incurred in handling a
late payment (extra servicing expense), and
– (2) Lost interest on the late payment itself (i.e., the lost use
value of the late installment); if the borrower had timely paid
the installment, the lender would have been able to invest that
amount and earn a return on it earlier
Default Interest
• Default interest is “forward”-looking; it compensates the
lender for the lost opportunity cost (i.e., interest)
associated with the lender’s investment of the principal
– Once borrower defaults, the default rate allows the lender to
“adjust” the interest rate to a rate more appropriate (now that
borrower has proven itself to be “riskier”)
– Parties can agree to whatever rates they wish, subject to usury
limits (which typically do not apply to most real estate
mortgage loans)
Westmark
• Consistent with the great weight of case authority, court
upheld both the late charge and default interest provisions
• Note: state statutes do commonly place maximum limits on
late charges [note 7, page 621]
– RSMo. § 408.140(1) (“If the contract so provides, a charge for
late payment on each installment or minimum payment in
default for a period of not less than fifteen days in an amount
not to exceed five percent of each installment due ....”)
Satisfaction of Mortgage
• When the mortgagor pays off the mortgage debt, the lien of
the mortgage is extinguished (it is no longer enforceable)
• But, if the mortgage/deed of trust still appears on the public
record, it is a “cloud” on the mortgagor’s title (as searchers
can’t tell whether or not it has been paid off)
• Thus, upon receiving full payment, the mortgagee must
execute a “release” or “satisfaction” of the mortgage
– In many states (including MO), mortgagee must also record it
Payoff Letters/Statements
• Today, most mortgage notes are prepaid (before their
originally scheduled maturity), either when
– (1) the mortgagor sells the mortgaged land, or
– (2) the mortgagor refinances the mortgage debt
• Mortgagor confirms the amount needed to make full
payment of mortgage debt by obtaining a “payoff
statement” from the lender
Missouri Statute [RSMo. § 443.130]
• Once mortgage is paid off, mortgagee must record
satisfaction within 45 days after request by mortgagor
• If mortgagee fails to do so, mortgagee is liable for a statutory
penalty of $300 per day, up to a maximum of 10% of the
amount of the mortgage, plus court costs and attorney fees
• If satisfaction is rejected by the recorder, mortgagee has 60
days (following receipt of notice of rejection) to record a
sufficient satisfaction
• Common law: lender had no legal duty to provide a “payoff
statement” (a confirmation of the balance of debt)
– Compare UCC § 9-210 (requires secured party to confirm
balance of debt upon written request, with $500 penalty if
secured party fails to timely respond)
– Restatement of Mortgages § 1.6 recognizes a legal duty to
deliver a payoff statement; such a duty is also imposed by
statute in a few jurisdictions
• In practice, lenders routinely provide payoff letters
(sometimes charging a fee unless prohibited by statute)
• Prior to sale from Uphoff to Mitchell,
Bank gives Uphoff (borrower) a payoff
amount of $124K (debt really = $125K)
• Uphoff tenders $124K to Bank, deeds
land to Mitchell at closing
• 1 week later, Bank says “We goofed;
payoff letter should’ve said $125K”
• Can Bank collect $1,000 from Uphoff?
• Can Bank enforce the mortgage against
Mitchell if $1,000 isn’t paid?
Problem 2
• Bank can still collect the remaining $1,000 from Uphoff in an
action on the note, which has not been satisfied (assuming,
of course, that Uphoff is personally liable for the debt)
• However, Bank probably can’t enforce the mortgage lien vs.
Mitchell (due to equitable estoppel)
– Mitchell relied on accuracy of payoff amount to complete the
purchase, believing he would receive a clear title
• Problem: payoff letters often state that they are subject to
“correction”; in that case, can Mitchell reasonably rely on the
payoff letter?