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Prepayment Penalty Upheld Despite Lender's Acceleration of the Debt

A recent decision by the U.S. Bankruptcy Court for the Southern District of New York has upheld the ability of a lender to charge and collect a prepayment penalty as part of its claim in bankruptcy despite the fact that the lender had accelerated the debt. Judge Bernstein authored the opinion in a case entitled In re 1141 Realty Owner LLC, 2019 WL 1270818 (Bankr. S.D.N.Y).
Generally speaking, it has long been thought that lenders waive the right to a prepayment penalty, sometimes referred to as a “make-whole” provision, where the lender accelerates the debt due to an event of default on the part of the borrower. The court in the 1141 Realty Owner LLC decision, following a previous decision in Illinois, notes two important exceptions to this rule: a) if a clear and unambiguous clause requires the payment of the prepayment premium even after default (in which case it is analyzed under state law as a liquidated damages provision);  or b) if the borrower intentionally defaults to trigger the acceleration and "evade" payment of the prepayment premium. In the agreement interpreted by the court in the 1141 Realty Owner LLC decision the word “acceleration” did not appear in the prepayment clause; however, the agreement did provide that any post default payment whenever made was a voluntary prepayment thus giving the lender the right to add the prepayment penalty to the bankruptcy claim.
While recognizing that this case interprets NY law and would not be binding on an Ohio court, this decision could signal the beginning of a new trend regarding these types of clauses and lenders may wish to consider adding language to their loan agreements that clearly and unambiguously provides for a prepayment penalty even after borrower default and the lender’s acceleration of the debt. Lenders may also wish to add language that any subsequent payment after default and acceleration is considered a prepayment. Of course, the prepayment penalty itself would still have to comply with the requirements of state specific case law defining an appropriate liquidated damages clause.

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