Loan Prepayment Penalties
It is generally accepted practice for commercial lenders to incorporate prepayment premiums or penalties into loan documents in order to counter act any potential lost interest or other costs resulting from the early payoff of a loan. These prepayment premiums may also be referred to as "make whole premium". Additionally, it is now common for lenders to provide for an "exit fee" when the loan is paid off. Exit fees in effect constitute additional or deferred interest and differ from prepayment premiums in that they are typically due at any time the loan is paid off even at the time of maturity, whereas prepayment premiums are usually only triggered upon prepayment of all or part of the loan.
These prepayment premiums and exit fees are the subject of recent litigation in New York and elsewhere, where lenders and borrowers advance different positions based upon their reading of the relevant loan documents.
In reviewing these cases it becomes clear that the precision of drafting may avoid disputes and save considerable litigation expense for all parties.
In the United States District Court for the Eastern District of Louisiana, in a case called Delta Rault Energy the court directly confirmed the collectibility of an exit fee payable upon acceleration, as an additional loan charge in a short-term mortgage loan where the borrower prepaid the loan in connection with a refinancing. The court rejected the borrower's contention that the exit fee was an unenforceable penalty, viewing the exit fee as additional consideration for the loan.
Contrary results were reached in two New York cases. In Anthracite Capital v. MP-555 West Fifth Mezzanine, in which the U.S. District Court for the Southern District of New York refused the lender an award of a "supplemental exit fee" called for in a mezzanine loan financing agreement secured by the loan and in Citadel Equity Fund Ltd., v. Aquilla where the same court denied the lender's request for payment of a "make whole premium". The court based this decision on those two cases on the language of the loan documents.
In order to eliminate any question regarding the applicability of an exit fee a straight forward clause which provides that the fee is an amount equal to a fixed percent of any prepayment or that the fee is due in all respects and under all circumstances upon full or partial prepayment of the loan or repayment upon maturity or the lender is not obligated to accept any prepayment or repayment unless the borrower pays the exit fee or the lender shall have no obligation to release any loan documents until the entire exit fee is paid.
Finally, the borrower should acknowledge that the exit fee constitutes additional consideration for the loan. In certain circumstances an exception to the payment of an exit fee may be provided where the borrower repays the loan prior to the maturity date with the proceeds of a new loan from the lender.