11/18/2014
• Lambert owns Free Market Shopping Center
Prepayment
– Equitable holds a mortgage on the Center, securing a $10MM mortgage loan (8% interest)
– Mortgage is payable in full at end of 10‐year term, in a “balloon payment,” in 2019
• In 2014, Lambert wants to pay off mortgage early, and tenders $10MM to Equitable
• Should Equitable be able to refuse this payment?
• Restatement § 6.1 rejects the “perfect tender in time” rule altogether; 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 expectation among lay persons that mortgage loans can be freely prepaid)
– Lender that wants to restrict prepayment should bear the burden of imposing clear contractual restrictions
• But: only two states (PA, MO) accept this view; the rest still apply the “perfect tender in time” rule
“Perfect Tender in Time” Rule
• Traditional rule: if mortgage is silent, mortgagee can refuse prepayment. Rationale:
– Lender should be able to get the benefit of the investment decision it made at time loan was made
– E.g., if current interest rates are now below the contracted‐for rate, the lender will suffer a “reinvestment loss” due to the prepayment
• In “remedies” terms, does it make sense to give mortgagee the right to specific performance of the promise to repay in accordance with the note? “Perfect Tender in Time” Rule
• It is true that prepayment by the borrower will impose a reinvestment loss on the lender, if market interest rates are now lower
• But, money damages would seem to make the lender “whole” (lender can presumably calculate its actual reinvestment loss)
• So why not let the borrower prepay (i.e., breach the contract), as long as the borrower pays lender for the damages the lender suffers as a result of the borrower’s breach?
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11/18/2014
Prepayment Clauses
• Mortgage loan documents typically contain one of three types of prepayment provisions
– (1) “Lock‐out”: prepayment is absolutely prohibited, or prohibited for a certain period
– (2) “Flat fee” (fee based on % of amount prepaid)
– (3) Yield maintenance clause (fee based on formula designed to approximate, as nearly as possible, lender’s actual reinvestment loss) • On these facts, Lambert’s prepayment actually benefits Equitable!
– Equitable’s interest on existing note = $800K/year
– Interest Equitable would receive if it re‐loaned principal at 10% market rate = $1MM/year
– Equitable could thus 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 (a) it not only suffered no loss, but (b) it received a ≈$750K benefit?
• Lambert owns Free Market Shopping Center Problem 3
– Equitable’s mortgage note provides for a prepayment fee = “6% of the amount prepaid”
• Lambert wants to prepay (balance = $10MM)
– At the time of the proposed prepayment, prevailing interest rates are now 10%
Prepayment Fees
• Weight of judicial authority: prepayment fee clause = 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 (at time of loan, size of possible reinvestment loss is uncertain)
– Percentage fee is a “reasonable” pre‐estimate of damages due to potential reinvestment loss
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11/18/2014
10‐Year, $10MM Loan: What Is Lender’s Reinvestment Loss Due to Prepayment (for Each 1% Decline in the Interest Rate)?
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After Year 1: $625,000
After Year 2: $574,000
After Year 3: $520,000
After Year 4: $462,000
After Year 5: $399,000
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After Year 6: $331,000
After Year 7: $257,000
After Year 8: $178,000
After Year 9: $92,000
Problem 3(d)
• After Equitable refuses Lambert’s prepayment, Lambert stops making his monthly interest payments on the Center’s mortgage loan
• After several months, Equitable accelerates the loan and demands full payment from Lambert
• Lambert tenders the full $10MM (+ accrued interest) and says “Now that you’ve accelerated, this is a ‘payment,’ not a ‘prepayment’ — and that means I don’t have to pay the $600K prepayment fee.”
• Is Lambert correct, or not?
Prepayment Fees
• Prof. Whitman has argued that if the mortgage note contains a percentage prepayment fee, then the mortgagor effectively has obtained an “option” to prepay
– 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
– Compare handling of earnest money deposits (Uzan)
• Westmark [p. 548]: court allowed lender to charge prepayment fee upon payment following acceleration
– Equitable’s reinvestment risk is the same, whether the payoff is voluntary or involuntary (payment or foreclosure following acceleration)
– But: the loan documents in Westmark were explicit —
they expressly allowed mortgagee to impose a prepayment fee if payment occurred following acceleration of the loan! [p. 549]
• If mortgage isn’t explicit, the weight of authority is that the mortgagor’s payment of the debt after accelera on by the mortgagee ≠ “prepayment” [LHD Realty, p. 550; note 4(a), p. 555]
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11/18/2014
Yield Maintenance Clauses
• Parties can’t be certain about future interest rates, but they can use a formula that would more precisely calculate the lender’s reinvestment loss due to prepayment
– Note 2, page 553: prepayment fee = present value of all future P&I payments on the note (discounted at the “reinvestment rate”), minus the outstanding principal balance due on the note at the time of the prepayment
Usury
• Usury laws establish a legal limit on interest rates
• Nominally, Missouri has a 10% usury limit [RSMo. § 408.030]
• Traditional rule: can’t enforce usurious interest rate
– Some state laws required disgorgement of all interest collected
– Other states required only disgorgement of interest collected above the legal rate
Questions
• Does this “yield maintenance” formula accurately reflect the lender’s damages?
• If this formula works, would the mortgagee choose to use a “percentage fee” provision instead?
• Suppose the mortgage documents provided that the prepayment fee would be the greater of (a) the yield maintenance formula or (b) 1% of the amount prepaid. Enforceable?
• In the 1970s/1980s, when inflation and interest rates skyrocketed, usury laws threatened the solvency of banks and S&Ls
– For example, some banks and S&Ls were having to pay 12%‐14% to attract deposits, but were legally prohibited from charging borrowers more than 10% (unless the state would raise the usury limit)
• Cost of potential bailout prompted federal pre‐
emption of state usury laws, allowing federally‐
regulated lenders to make mortgage loans w/out regard to state law usury limits
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11/18/2014
• Today, due to federal pre‐emption and state revision of usury law, usury law is mostly a dead letter
– E.g., federally regulated mortgage lenders are not subject to state law limits
– E.g., payday lenders in Missouri are subject to maximum interest rate of 1,950%
• MO: 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 isn’t a federally regulated lender [Do you see the usury trap here?]
Late Fees and Default Interest
• Borrower defaults by making its payment more than 20 days late
• Lender imposes a default interest rate, and also assesses a “late fee” on the late payment • Is that “double counting” by the Lender (collecting twice for the same harm)?
Late Fees/Default Interest: Westmark
• Note: “If the unpaid balance hereof is not received by Holder on the Maturity Date, such amount shall bear interest at the Note Rate plus two (2%) per annum (the “Default Rate”)....” [Default interest]
• 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 charge]
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 for “riskier” borrower
– Parties can agree to whatever rates they wish, subject to usury limits (which would typically not apply to commercial real estate mortgage loans)
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11/18/2014
Late Fees v. Default Interest
• By contrast, the late charge or late fee is “backward”‐looking; it compensates the lender for:
– (1) The lender’s administrative expenses and costs incurred in handling a late payment, and
– (2) Lost interest on the late payment itself (i.e., the lost use value of the late installment) [If borrower had timely paid installment, lender would have been able to invest that amount and earn a return on it earlier]
Westmark
• Court upheld both the late charge provision and the default interest provision as valid
– Westmark is consistent w/weight of judicial authority under state law
• State statutes do commonly place maximum limits on late charges [note 7, page 566]
– 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
Missouri Statute [RSMo. § 443.130]
• When mortgagor pays off the mortgage debt, the lien of the mortgage is extinguished
• But, if the mortgage/deed of trust still appears on the public record, it’s a cloud on the mortgagor’s title (searchers won’t know it has been paid off)
• Thus, mortgagee must execute a “release” or “satisfaction” of the mortgage
• 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
– In many states (MO), mortgagee must also record it
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• If the mortgagor makes all of the payments as they come due, the mortgage debt is fully “paid off” at its originally scheduled maturity date
• Today, however, most mortgage notes are prepaid (before their originally scheduled maturity), either when
– (a) the mortgagor sells the mortgaged land, or
– (b) 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
• In conjunction with sale of mortgaged land to Mitchell, Bank provides Uphoff (borrower) a payoff amount of $124,000
– Uphoff tenders that amount, then deeds land to Mitchell at closing
• 1 week later, Bank says “Sorry, the payoff letter was wrong; it should’ve said $125,000”
• Can Bank collect $1,000 from Uphoff? • Can Bank enforce the mortgage against Mitchell?
Problem 2
Payoff Statements
• Common law: lender had no legal duty to provide a “payoff statement” (confirmation of balance of debt)
– Compare UCC § 9‐210 (which requires secured party to confirm balance of debt upon written request)
– Restatement of Mortgages § 1.6 recognizes a legal duty; such a duty is also imposed by statute in some (but not all) jurisdictions
• In practice, lenders routinely provide payoff letters (in some cases for a fee, unless prohibited by statute) • Bank can still collect the remaining $1,000 from Uphoff (assuming Uphoff is personally liable for the debt, which has not been satisfied)
• Bank probably can’t enforce the mortgage lien vs. Mitchell (equitable estoppel)
– Mitchell reasonably 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?
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