November 21, 2013 Articles

"Make-Whole" Claims Triggered by Automatic Acceleration

Courts are split over what to do when loan agreements fail to address this issue

by Brendan M. Gage

The lender makes money from the interest that the borrower pays on a loan. A typical loan agreement will require the borrower make interest payments during the life of the loan until the maturity date when the balance of the loan becomes due. If the borrower wishes to pay off the loan before the maturity date (i.e., "prepay" the loan), the lender will be deprived of anticipated interest payments. The lender's losses can be particularly acute if the borrower prepays the loan "in an environment where prevailing interest rates are lower than those the parties bargained for at the time the [loan agreement] was [entered]." In re Chemtura Corp., 439 B.R. 561, 596 (Bankr. S.D.N.Y. 2010).

To compensate for the loss of interest caused by prepayment, the lender may include a "make-whole" provision in the loan agreement. A make-whole provision will provide for a fee, premium, or penalty that "serves as a proxy for the lender's actual damages in the event of prepayment." In re S. Side House, LLC, 451 B.R. 248, 268 (Bankr. E.D.N.Y. 2011). The make-whole amount is typically based on a percentage of the principal balance at the time of prepayment or on a yield maintenance formula that approximates the lender's expected return on interest.

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