By Joe Forward, Legal Writer, State Bar of Wisconsin

Oct. 27, 2010 – The District I Wisconsin appeals court recently nailed a limited liability company that commenced litigation to challenge a prepayment penalty fee of $1.6 million despite a lender’s offer to reduce the fee to accommodate the company.

In 2004, BV/B1, LLC entered into a contract with InvestorsBank to borrow $4.85 million to finance a commercial building in Fond du Lac. Under the contract, the 10-year term came with a fixed interest rate of 6.75 percent and did not require personal guarantees. The appeals court explained that these terms were unusual in commercial loans and risky for the lender.

To accommodate for the risk, the contract required a prepayment penalty, after an 18-month grace period, if the loan was paid before maturity.

The prepayment penalty clause read, in relevant part: “[T]he prepayment penalty shall be equal to 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.”

After the 18-month grace period expired, BV/B1 granted Graff/Goldman Interests, Inc. an option to purchase the building. BV/B1 notified InvestorsBank of a possible sale.

A loan administrator for InvestorsBank prepared a payoff letter but did not assess a penalty, applying the wrong prepayment penalty clause. A second revised letter was sent, noting a prepayment penalty of $1.6 million according to the terms of the contract.

Robert Schmidt, a member of BV/B1, met with InvestorsBank’s president to negotiate the prepayment penalty amount. Schmidt stated that BV/B1’s deal with Graff/Goldman would fail if the full $1.6 million penalty were assessed, resulting in a lawsuit. That would “make the situation … ugl[y] for everyone,” Schmidt told the president.

Hoping to maintain a long-term relationship with BV/B1, InvestorsBank removed the “plus 2.5%” from the penalty equation, and assessed a new penalty of approximately $797,000. BV/B1 paid the reduced amount to close its deal with Graff/Goldman.

After closing, BV/B1 sent a letter to InvestorsBank stating that it reserved the right to contest the validity and enforceability of the prepayment penalty. Shortly after that, BV/B1 sought immediate return of the penalty fee it paid, and threatened litigation.

InvestorsBank did not return the fee, and BV/B1 filed a lawsuit in Milwaukee County Circuit Court, asking the court to declare, as a matter of law, that “the prepayment penalty clause in the parties’ contract did not impose a prepayment penalty fee in this instance.”

InvestorsBank counterclaimed for the full $1.6 million prepayment penalty – the full amount less the $797,000 penalty already paid – assessed in the revised payoff letter sent to BV/B1.

The circuit court granted summary judgment to InvestorsBank for the remainder of $1.6 million not paid by BV/B1, plus prejudgment interest. BV/B1 appealed. 

Prepayment penalty clause enforceable? 

BV/B1 made several arguments that the prepayment penalty clause was not enforceable. However, in BV/B1, LLC v. InvestorsBank, 2009AP2721 (Oct. 26, 2010), the appeals court rejected all of them, and concluded that BV/B1 owed the balance of $1.6 million.

First, BV/B1 argued that under industry custom, prepayment penalty clauses do not apply if interest rates associated with the prepayment penalty – here the yield on a U.S. Treasury Bond – increase or stay the same.

But the appeals court explained that a court may not consider industry custom or usage if there are no ambiguous terms. Here, the court concluded, “there are no ambiguous terms which necessitate turning to trade practices or industry usage.”

“If [BV/B1] wished the prepayment penalty to hinge on a comparison of interest rates, it should have negotiated that language into the contract,” the court wrote. “It didn’t, and now, it cannot go back in time and convince us that the language of the contract says something it doesn’t.”

BV/B1 next argued that basic mathematical “order-of-operations” principles would lead to a different calculation of the prepayment penalty, and therefore the clause was ambiguous.

That is, “order-of-operations principles require multiplication and division to be performed before addition and subtraction.” Applying the principle here, BV/B1 argued, leads to an $833,798 penalty, not a $1.6 million penalty.

But the court concluded that the “plain language of the clause does not direct us to apply order-of-operations principles” and “[i]t makes no sense that the parties intended for the actions in their sentence to be performed in an order other than the one in which they were written.” The court also noted that such a calculation would produce an “absurd result.”

Further, BV/B1 argued that the clause is unreasonable because it imposes a “punitive penalty.” The court disagreed, noting that “[t]here is no law in Wisconsin that prohibits parties from contracting to whatever terms they please, provided they are not illegal.”

Remainder of prepayment penalty waived? 

BV/B1 argued that InvestorsBank waived its right to counterclaim for the balance of $1.6 million “because it accepted the reduced fee and released the collateral, and waited too long to enforce its right to the greater sum.”

InvestorsBank made no such waiver, the court explained, because InvestorsBank reduced the fee in exchange for BV/B1’s “future business and agreement that it would not pursue litigation,” the court explained.

“BV/B1 rejected that offer when it informed InvestorsBank that it sought immediate return of the reduced prepayment penalty fee and then commenced litigation,” the court wrote. “BV/B1 cannot now seek to enforce an offer that it previously rejected.”

The appeals court also rejected BV/B1’s argument that the reduced fee was an “accord and satisfaction,” an agreement to discharge an existing disputed claim.