A Pennsylvania court recently rejected a foreclosing lender's prepayment premium claim in In re Atrium View, LLC, 2008 WL 5378293 (Bkrtcy.M.D. Pa. 2008).
Nineteen (19) months after the loan’s origination, the mortgage lender sought enforcement of Note’s prepayment provision requiring “six (6) months interest” on any principal balance being repaid within three (3) years of the closing.
After reiterating dual criteria for enforcing prepayment premium demand - - that prepayment must be reasonable under state law and, as required by 11 U.S.C. §506(b), be contained in loan documents and “reasonable” - - the Court determined that Pennsylvania law did not bar prepayment premiums and focused on “reasonability”.
The Court noted that prepayment premium’s purpose is ensuring that a lender “obtains the benefit of the bargain by protecting it against falling interest rates” and the burden of establishing “reasonableness” requires demonstrating how accurately the premium “predicts actual losses that will be incurred” if obligation is paid before the term’s end.
The Court ruled that because its "[i]n the current residential subprime mortgage industry, a typical prepayment premium is six months' interest” argument provided no “prepayment premium approximates reasonably predicted losses” evidence, the lender failed to establish premium’s reasonableness and rejected the prepayment claim.
Unfortunately, the In re Atrium View holding ignores the impact of failing to protect against declining interest rates.
Like insurance companies and investment funds committed to maintaining investors’ returns based on anticipation of long-term cash flow for mortgage investments, lenders often make commitments based on anticipated interest returns.
If high-yielding mortgages are prepaid when interest rates have fallen, lenders may be unable to maintain yield commitments to their investors, including guaranteed annuity payments.
Another inequity the In re Atrium View ruling imposes is that junior lenders might receive funds otherwise used to pay senior lender’s prepayment fee.
Because junior lenders advance money with the awareness of the senior mortgage’s terms, including the prepayment premiums, In re Atrium View places junior lenders in a stronger secured position at the senior lender’s expense, which, in turn, encourages senior lenders to prohibit secondary lending.
Wednesday, August 19, 2009
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