Challenge to prepayment penalty backfires

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An Oct. 26 opinion from the Wisconsin Court of Appeals provides guidance on how not to draft a prepayment penalty if representing a borrower, and how not to make payment if you contest the amount owed.

The court held that, when the borrower sent a reservation of rights despite paying an agreed-upon settlement amount, the lender was then free to seek full payment.

The facts are complicated. BV/B1, LLC, negotiated a $4.85 million loan from InvestorsBank to construct a commercial building.

The terms of the loan differed from industry standard in several respects: it locked in an interest rate for ten years; it provided an interest rate below the market rate; and it required no personal guarantees from the borrowers.

Also, instead of a standard prepayment penalty provision of 90 days interest on the outstanding principal balance on the date of repayment, it provided for a penalty of “the fixed rate on the loan minus the yield on a US Treasury Bond with a maturity similar to the number of years remaining on the fixed rate loan plus 2.5% times the number of years remaining at a fixed rate times the outstanding principal balance of the loan.”

BV/B1 later arranged a sale of the property to a third party and requested a payoff letter from InvestorsBank. A loan administrator prepared a payoff letter that included no prepayment penalty. Upon discovery of the error, InvestorsBank sent a revised payoff letter that included a prepayment penalty of more than $1.6 million. The penalty far exceeded what is standard in the commercial lending business.

After negotiations between the parties, a penalty of approximately $800,000 was agreed on.

However, after the closing on the sale of the property to the third party, and after wiring the agreed-upon sum to InvestorsBank, BV/B1 then faxed a letter stating that it was reserving its right to contest the prepayment penalty.

Investors Bank sent a satisfaction to BV/B1, stating that the loan was “satisfied and released as security.”

Afterwards, BV/B1 filed a declaratory judgment action, asking the court to hold that it owed no prepayment penalty. InvestorsBank counterclaimed, seeking the balance of the entire $1.6 million fee it requested in the revised payoff letter.

The circuit court granted summary judgment to InvestorsBank, and BV/B1 appealed, but the Court of Appeals affirmed in an opinion by Judge Kitty K. Brennan.

After finding that the $1.6 million penalty was accurately calculated pursuant to the penalty clause’s methodology, the court rejected several arguments from BV/B1 on reasonableness grounds.

BV/B1 argued that the penalty was unreasonable because it is contrary to trade practices, and was punitive.

But the court found that the parties were both sophisticated, and negotiated freely to the terms in the contract. It also found that BV/B1 obtained consideration during those negotiations in the form of no personal guarantees and a low interest rate.

Judge Brennan wrote, “As a sophisticated party, if BV/B1 did not wish to pay the prepayment fee, it could have negotiated other terms. It didn’t and now it is bound by the terms of the parties’ agreement.”

Counterclaim

Turning to the counterclaim by InvestorsBank, the court concluded that it was not waived when InvestorsBank accepted the reduced fee and released the collateral.

The court found that acceptance of roughly half of the prepayment penalty was not a waiver of right to full payment, but merely an offer made to facilitate the sale and avoid litigation.

It found, “BV/B1 rejected that offer when it informed InvestorsBank that it

sought immediate return of the reduced prepayment penalty fee and then commenced

litigation. BV/B1 cannot now seek to enforce an offer that it previously

rejected.”

The court further held that the release of its lien was not an accord and satisfaction that extinguished InvestorsBank’s right to seek the rest of the prepayment penalty.

The court concluded that, because BV/B1 sent the letter reserving its right to contest enforceability of the prepayment penalty, there was no binding contract. “Because BV/B1 never assented to InvestorsBank’s offer, neither party was prohibited from seeking redress under the terms of the contract.”

Attorney Dean P. Laing, who represented InvestorsBank, agreed that the court reached the right result.

“We argued that there was either a deal or not,” Laing said in an interview. “If there was no deal, then all bets are off for everyone, and the court agreed.”

Laing added that, in his view, someone at BV/B1 thought they could get the release by agreeing to pay half the prepayment penalty, and then turn around and say, “Just kidding.”

“It was a very expensive decision. We were willing to accept half.”

Regarding the unusual prepayment penalty clause, Laing said it was drafted by the bank president, and is not pattern language.

Analysis

Despite the court’s holding, attorneys faced with similar facts do have a good argument that the parties should be bound to the compromise — the voluntary payment doctrine.

The voluntary payment doctrine “places upon a party who wishes to challenge the validity or legality of a bill for payment the obligation to make a challenge either before voluntarily making the payment, or at the time of making the payment.” Putnam v. Time Warner Cable, 2002 WI 108, 255 Wis.2d 447, 649 N.W.2d 626 (2002).

InvestorsBank did argue that the doctrine applied in the circuit court, but the court found the payment and the reservation of rights were effectively simultaneous, because the reservation was sent approximately an hour and a half later.

That ruling was not appealed, inasmuch as InvestorsBank ultimately prevailed and got an even better result than if the doctrine did apply.

However, a strong argument can be made that the reservation of rights was not made “at the time of making the payment,” and therefore, the doctrine should have barred BV/B1’s suit.

Nothing in the Court of Appeals’ opinion explicitly or implicitly suggests the doctrine would not apply.

In addition, most Wisconsin case law addressing the doctrine addresses whether it application would be inequitable.

As a result, there is no precedent to prevent an attorney from asserting the doctrine, and arguing that an objection made an hour and a half after payment is not simultaneous with the payment.

In fact, a defendant could even use this case to make a public policy argument in favor of the doctrine’s application. It would have prevented very expensive litigation (and the hiring of mathematicians as expert witnesses), if the circuit court had decided this case on that basis. The conduct in this case after the closing could be characterized as gamesmanship that the doctrine is intended to prevent.

What the Court held

Case: BV/B1, LLC, v. InvestorsBank, No. 2009AP2721

Issues: Is a prepayment penalty that far exceeds trade practices enforceable?

Can a lender enforce a penalty, despite sending a lien release, where the borrower sought return of its partial payment?

Holdings: Yes. Where sophisticated parties bargained for the clause, it is enforceable.

Yes. Where the borrower rejected the settlement, the lender could seek full payment.

Attorneys: For Plaintiff: Kathy L. Nusslock, Gregory J. Sell, Beth E. Hanan, Milwaukee; For Defendant: Dean P. Laing, Milwaukee

David Ziemer can be reached at [email protected].