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The Enforceability of Prepayment Premium Provisions
Lessors and lenders need to be aware of a recently issued U.S. District Court decision addressing the enforceability of a prepayment premium in a mortgage loan context. The decision in River East Plaza, LLC v. The Variable Annuity Life Company (Slip Copy, 2006 WL 2787483 (N. D. Ill.)) was rendered on Sept. 22, 2006, by the U.S. District Court for the Northern District of Illinois (Eastern Division), construing Illinois law.
In its decision, the court found that the particular prepayment premium required to be paid in connection with prepayment of a mortgage loan was an unenforceable penalty. The type of prepayment provision at issue in the case is generally referred to as a 'yield maintenance clause,' which compensates the lender for possible lost interest by making the lender whole on a similar investment. The borrower is required to pay the interest spread between the actual loan to be prepaid and a hypothetical alternative investment. In this particular transaction, the yield maintenance provision required discounting the outstanding principal and in-terest which would be due over the term of the original transaction to present value at the reinvestment rate, and the reinvestment rate used was the yield to maturity on a U.S. Treasury bond or note having a similar maturity as the unexpired term of the mortgage loan.
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