Legal Updates

Bankruptcy Court Disallows Secured Creditor’s Claim for Prepayment Penalty

A bankruptcy court recently disallowed a secured creditor’s claim for a prepayment penalty due to the creditor exercising its acceleration rights before the debtor filed for bankruptcy.  In In re Tara Retail Group, LLC, No. 17-bk-57, 2018 Bankr. LEXIS 2854 (Bankr. N.D. W. Va. Sept. 19, 2018), the debtor borrowed $13,650,000 under a loan agreement and note.  The agreement provided for the payment of a prepayment penalty if the debtor tendered a prepayment during the continuation of an event of default.  The agreement further permitted the secured creditor to declare all obligations owing to it immediately due and payable upon an event of default.  After a historic flood washed away the only commercially reasonable access to the debtor’s property, the debtor defaulted on its loan and the secured creditor invoked its acceleration rights by declaring all obligations owing to it immediately due and payable.  The debtor subsequently filed for bankruptcy and the creditor filed a proof of claim seeking, among other things, $3,139,776.71 as a prepayment penalty.

In disallowing the secured creditor’s claim for a prepayment penalty, the court interpreted the language of the underlying loan agreement and held that the creditor forfeited its right to a prepayment penalty when it exercised its acceleration rights.  Specifically, the court held that the acceleration effectively modified the maturity date of the note to the date of acceleration, making a “prepayment” impossible.  The court held that the language of the agreement did “not specifically require the payment of the premium based upon the acceleration of the [n]ote.  Rather, in the court’s view, the relevant language contemplate[d] a ‘prepayment’ during an event of default in the absence of an accelerated [n]ote.”  Simply put, the relevant provisions of the loan agreement did not entitle the creditor to a prepayment premium because the debtor could no longer “prepay” the note.  Based on the court’s reasoning, a secured creditor may experience a different result if its loan agreement expressly provides for the payment of a prepayment penalty upon acceleration.