Opinion
8:24-bk-00011-RCT Adv. 8:24-ap-00225-RCT
08-23-2024
In re: DIXON HOLDINGS, LLC, Debtor. v. WORLD BUSINESS LENDERS, LLC and WBL SPO I, LLC, Defendants. DIXON HOLDINGS, LLC, Plaintiff,
Chapter 11
ORDER GRANTING IN PART PLAINTIFF'S MOTION FOR SUMMARY JUDGMENT AS TO COUNT I
Roberta A. Colton United States Bankruptcy Judge
On August 9, 2024, this Court held a hearing on Debtor-Plaintiff's Motion for Summary Judgment as to Count I (Doc. 6) and Defendants' response thereto (Docs. 11, 12). As explained below, the Court grants Debtor's motion to the extent that the Court finds that interest in excess of 25% will not be allowed, and the Prepayment Premium is an unenforceable penalty. Otherwise, the motion is denied.
I. Standard of Review
Summary judgment is appropriate if the movant shows that there is no genuine dispute as to any material fact and the movant is entitled to judgment as a matter of law. The Court must draw all inferences from the evidence in the light most favorable to the non-movant and resolve all reasonable doubts in that party's favor. The moving party bears the initial burden of showing the Court, by reference to materials on file, that there are no genuine issues of material fact that should be decided at trial. When a moving party has discharged its burden, the non-moving party must then go beyond the pleadings, and by its own affidavits, or by depositions, answers to interrogatories, and admissions on file, designate specific facts showing there is a genuine issue for trial.
Fed.R.Civ.P. 56(a), made applicable here by Fed.R.Bankr.P. 7056.
See Porter v. Ray, 461 F.3d 1315, 1320 (11th Cir. 2006) (citation omitted).
See id. (citation omitted).
See id. (citation omitted).
II. Background
Debtor-Plaintiff Dixon Holdings, LLC is a limited liability company, and in 2023, a family dispute arose over the management of the company. On July 12, 2023, Debtor filed an amendment to its Articles of Organization that removed Renata Angioli and replaced her with her sister, Roberta Masnyj, as manager of Debtor. On July 28, 2023, Angioli (purportedly on behalf of Debtor) entered into a $650,000 loan agreement with World Business Lenders, LLC ("WBL").WBL contends that Debtor defaulted on the loan by failing to make the first payment due on August 4, 2023.
Doc. 6-3.
Doc. 6-2. The promissory note and security agreement are filed at Doc. 6-2, p. 60-69.
Doc. 11-1, p. 4, ¶ 11; Doc. 11-3, p. 1.
The loan is secured by a first mortgage against Debtor's principal place of business, an apartment building located in New York (the "Mortgaged Property"). The Mortgaged Property is valued at $2.4 million on Debtor's sworn schedules filed in this case.
Doc. 6-2, p. 1-29.
Doc. 52, p. 6.
The loan has a stated interest rate of 24.55% APR and closing costs of $43,711.62.However, upon default, the default interest rate increases to 32.5%. The loan agreement provides that all matters arising out of or relating to the loan agreement shall be governed by the laws of the state of the borrower's address set forth in paragraph 1, which is New York.
Doc. 6-2, p. 54.
POC 13-1, p. 13, ¶ 2.
(Doc. 6-2, p. 60, 66). There is no choice of law issue here. "The 'public policy' against usury . . . [in Florida is] not so strong as to overcome the policy in favor of giving effect to the expressed intentions of contracting parties, even though as a factual matter the designation may indeed have been motivated by a desire to 'evade' Florida's usury law." Morgan Walton Properties, Inc. v. International City Bank & Trust Co., 404 So.2d 1059, 1062 (Fla. 1981); see also Continental Mortg. Investors v. Sailboat Key, Inc., 395 So.2d 507, 512-13 (Fla. 1981) (upholding an agreement to apply foreign law when the foreign jurisdiction had a relation to the potentially usurious transaction).
Under the terms of the loan, Debtor was to make 155 weekly interest-only payments of $2,804.79 (which would total $437,547.28 over the three-year loan period) and then make a final balloon payment of $652,804.83 on July 24, 2026. There is a Prepayment Premium under the loan, but it does not apply if Debtor prepaid the loan in full after twelve months, as long as Debtor had not missed any payments.
POC 13-1, p. 13, ¶ 3.
POC 13-1, p. 13-14, ¶ 4.
The Prepayment Premium applies in two scenarios. First, if Debtor prepaid the loan within the first twelve months and had not missed any payments, Debtor would have to pay a Prepayment Premium calculated as the amount of interest that would have been paid during the full twelve-month period ($145,849.09) less the amount of interest that Debtor had already paid. Second, if Debtor prepaid the loan at any time, but had previously missed a payment, Debtor would have to pay a Prepayment Premium calculated as the greater of: (1) 15% of the unpaid principal and (2) the amount of interest that would have been paid during the full three-year period ($437,547.28) less the amount of interest that Debtor had already paid.
POC 13-1, p. 13-14, ¶ 4.
POC 13-1, p. 13, ¶ 4. Prepaying the loan when there has been a single missed payment results in WBL being guaranteed the full three years of interest payments. The Prepayment Premium is "equal to the greater of (a) fifteen percent (15%) of the amount of the unpaid Principal as of the date of such prepayment and (b) the aggregate amount required to be repaid by Borrower to Lender during the Repayment Period reduced by the sum of (i) the aggregate amount of any payments made by Borrower to Lender . . . before such prepayment . . . and (ii) the amount of the unpaid Principal as of the date of such prepayment." (POC 13-1, p. 13, ¶ 4). Thus, under the fact of this case, the Prepayment Premium is the greater of (a) $97,500 (15% of $650,000) or (b) $431,937.70: calculated as 1,087,547.28 (total amount due under the loan after three years) minus $5,609.58 (actual interest paid) minus $650,000 (unpaid principal). The calculation in (b), stated more clearly, is simply the amount of interest that would have been paid during the full three-year loan period less the amount of interest that Debtor had already paid.
Finally, if a default occurred and WBL accelerated the loan, as in this case, the loan specifically states that the payment of principal and interest shall be deemed a prepayment and shall be accompanied by a Prepayment Premium. According to WBL, Debtor has made two weekly interest payments, totaling $5,609.58, on the loan. Thus, to calculate the Prepayment Premium (as set forth on the proof of claim), one subtracts $5,609.58 in interest paid from the total amount of interest that would have been paid during the three-year loan period ($437,547.28) to arrive at the Prepayment Premium of $431,937.70.
POC 13-1, p. 13, ¶ 4.
Doc. 11-3.
As part of the loan, Debtor and WBL also entered into a Holdback Agreement, whereby WBL retained $555,506.08 of the loan funds (the "Holdback Funds"). The Holdback Funds were subject to WBL's "control" and could be accessed only for payment to "utility companies, state and local real estate taxing authorities, insurance companies, and general contractors and subcontractors." The Holdback Funds were not available for Debtor's general business expenses; they could only be used for expenses designed to protect and preserve WBL's interest in the Mortgaged Property.
Doc. 6-2, p. 83.
Doc. 6-2, p. 82.
Debtor was required to submit invoices for review by WBL before WBL would pay them from the Holdback Funds. WBL would then pay the invoices directly to the vendor, subject to WBL's "sole reasonable discretion." At the loan closing, WBL paid $29,472.94 for property taxes and $21,309.36 for property insurance for the Mortgaged Property from the Holdback Funds. No further distributions were made from the Holdback Funds.
Doc. 6-2, p. 82.
Doc. 6-2, p. 82.
Doc. 6-2, p. 92-93.
In the event of a default, WBL had the right to keep the Holdback Funds and apply them to any amounts due to WBL under the loan. Neither the word "escrow" or "escrow agent" appears anywhere in the Holdback Agreement, and nothing in the Holdback Agreement requires a segregated account for the Holdback Funds. Instead, the Holdback Agreement simply states that the Holdback Funds "shall be disbursed directly by Lender" for the approved expenses.
Doc. 6-2, p. 83.
After defaulting on the loan, Debtor filed for bankruptcy relief under Chapter 11 on January 2, 2024. WBL SPO I, LLC, a wholly owned subsidiary of WBL, filed a proof of claim ("POC") in Debtor's bankruptcy case. The POC seeks $610,378.33, which is comprised of the following amounts:
Doc. 11-1, ¶ 1.
Defendants state that WBL is the former owner of the loan and the current servicer of the loan on behalf of WBL SPO I, LLC. (Doc. 11-1, p. 1, ¶ 1).
Principal
$650,000.00
Interest
$83,876.71
NSF Fees
$70.00
Prepayment Premium
$431,937.70
Holdback Funds
($555,506.08)
Debtor has filed an adversary complaint against WBL and WBL SPO I, LLC (collectively, "Defendants"). Debtor asserts two claims in its adversary complaint: Count I - Objection to Claim and Count II - Declaration as to Claim Amount and Secured Status of Claim.
On July 11, 2024, this Court held a confirmation hearing in the main bankruptcy case, during which Debtor and Defendants agreed that the resolution of the POC (i.e., Count I of the adversary complaint) was a gating issue for confirmation of Debtor's Chapter 11 plan. As a result, they agreed that Count I should be bifurcated and considered by the Court on an expedited basis.The Court set a summary judgment briefing schedule as to Count I and then held a hearing on Debtor's Motion for Summary Judgment.
Doc. 3.
III. Debtor's Motion for Summary Judgment
Debtor makes three arguments in support of its Motion for Summary Judgment as to Count I of its adversary complaint: (1) Angioli lacked corporate authority to execute the loan documents and bind Debtor; (2) the POC should be disallowed because the loan charged a criminally usurious interest rate of more than 25%; and (3) the POC should be disallowed to the extent that the Prepayment Premium consists of unmatured interest or the economic equivalent thereof. Accordingly, the Court will analyze each argument.
A. Corporate Authority
Debtor first argues that the POC should be disallowed, because Angioli lacked corporate authority to execute the loan documents and bind Debtor. However, at the hearing, the parties agreed that this issue presents a question of fact that cannot be resolved on a motion for summary judgment.
B. Usury
Next, Debtor argues that the POC should be disallowed, because the loan charged a criminally usurious interest rate under New York law of more than 25%. In making this argument, Debtor assumes that the Holdback Funds of $555,506.08 cannot be considered principal advanced under the loan. Defendants respond that because the Holdback Funds were being held for the benefit of Debtor and were not available for WBL's use, they must be considered as part of the amount funded under the loan. Although Debtor makes a persuasive argument that the Holdback Funds cannot be considered amounts loaned to Debtor (as opposed to being an available line of credit), the Court agrees that questions of fact exist regarding: (1) whether WBL truly held the funds in a segregated escrow account (and thus the funds were not available for WBL's use); and (2) whether Debtor immediately communicated with WBL upon finding out about the loan and directed that none of the Holdback Funds be disbursed (as alleged at the hearing). Thus, whether the Holdback Funds can be considered part of the amount funded under the loan cannot be determined on a motion for summary judgment.
N.Y. Penal L. § 190.40. New York's civil usury cap is 16%, but limited liability companies cannot raise the defense of civil usury. See N.Y. Limit. Liab. Co. § 1104(a). However, limited liability companies can raise the defense of criminal usury. See N.Y. Limit. Liab. Co. § 1104(c).
However, even if the entire $650,000 constituted the principal loan amount, the Court finds that the loan charged a criminally usurious default interest rate of more than 25%. The POC seeks $83,876.71 in interest on the loan through the petition date. If the entire $650,000 was loaned, the interest rate charged and sought in the POC is 29.81%:
Interest Rate = interest charged/principal advanced x 100 loan duration/365 days
= $83,876.71 interest/ $650,000 principal x 100 158 days/365 days
= .12904 x 100 .43288
= 29.81%
Defendants do not explain exactly how they calculated the $83,876.71 in interest sought in the POC, but it appears that the interest amount is based on post-default interest (at 32.5%), given that Defendants contend that Debtor defaulted on August 4, 2023-one week into the loan. Defendants argue that post-default interest cannot be included in the calculation to determine whether a loan charges a criminally usurious interest rate. The law in New York is not clear on this issue. However, the law in New York is clear that if the Court finds that the loan charges a criminally usurious interest rate, then the loan is void ab initio.
According to Defendants, Debtor made two weekly interest payments on August 11 and August 18. (Doc. 11-3). So, one would assume the remaining interest charged would be calculated as 144 days (158 days from the date of the loan to the bankruptcy filing minus 14 days of interest paid) multiplied by the default per diem of $578.77, which equals $83,342.88. However, the POC seeks interest of $83,876.71. It is unclear what makes up the difference of $533.83.
See, e.g., Madden v. Midland Funding, LLC, 237 F.Supp.3d 130, 146 (S.D.N.Y. 2017) (stating that "although the issue may ultimately have to be settled by the New York Court of Appeals, I conclude, based on Emery and its progeny, that New York's criminal usury cap applies to prevent a creditor from collecting interest above 25% on a defaulted debt"); Blue Citi, LLC v. 5Barz International Inc., 338 F.Supp.3d 326, 337 (S.D.N.Y. 2018) (stating that "while it is possible the New York Court of Appeals will see the issue differently, this Court finds that the policy judgments underlying the usury laws do not apply to agreed-upon default interest rates. Rather, this Court concurs with the majority view in this Circuit that default interest provisions do not render a note usurious").
See Adar Bays, LLC v. GeneSYS ID, Inc., 28 F.4th 379, 382-83 (2d Cir. 2022) (citing Adar Bays, LLC v GeneSYS ID, 157 N.Y.S.3d 800, 809, 2021 WL 4777289 (N.Y.A.D. 4 Dept. Oct. 14, 2021)).
There is currently a split of authority in New York federal courts on the issue of whether post-default interest can be included in the calculation to determine if a loan charges a criminally usurious interest rate. Initially, the Second Circuit in Manfra, Tordella & Brookes, Inc. v. Bunge stated in a footnote that "usury laws do not apply to defaulted obligations."
794 F.2d 61 (2d Cir. 1986).
Id. at 63 n.3 (citing American Express Co. v. Brown, 392 F.Supp. 235, 238 (S.D.N.Y.1975); Bloom v. Trepmal Construction Corp., 29 A.D.2d 951, affd, 23 N.Y.2d 730 (1968)).
Later, the court in Madden v. Midland Funding, LLC challenged that statement from Manfra and other courts' reliance on it, stating:
237 F.Supp.3d 130 (S.D.N.Y. 2017).
Because the interest rate on the note [in Manfra] was above the civil usury cap but below the criminal usury cap, the Manfra footnote- which is dictum in any event-cannot definitively be said to have ruled out application of the criminal usury cap to defaulted
obligations. But its language does not distinguish between the two caps, lending some support to Defendants' position. . . . As a federal court applying state law, [I am] generally obliged to follow the state law decisions of state intermediate appellate courts. I will thus look first to decisions of New York state courts . . ..
Id. at 141 (quotation marks and internal citations omitted).
The Madden court then surveyed New York state court decisions, stating:
[There are cases that have] held that parties were free to agree to an increased interest rate upon default or maturity of an obligation, and that the fact of such an increase would not be considered an impermissible penalty. Union Estates Co. explained that such an increased rate would still be subject to an unconscionability analysis, suggesting that the rate charged upon default was not without bounds. . . . [Furthermore], several more recent New York cases have held that, where a contract provision allows collection of interest at "the highest interest permitted under the law," New York's criminal usury cap applies to prevent a creditor from collecting interest above 25% even in default. One decision held outright that the interest on a defaulted mortgage above 25% was "a criminally usurious rate." These cases are strong indicators that New York's criminal usury cap applies even to defaulted obligations.
* * *
Based on this survey of New York state cases, I believe that the New York Court of Appeals, were it to face this situation, would hold that the criminal usury cap limits interest charged on debts to 25% annually, even for defaulted debts. I will next address federal court decisions addressing this question, bearing in mind my obligation to follow New York law as described by New York State's courts.
Union Estates Co. v. Adlon Const. Co., 221 N.Y. 183, 189, 116 N.E. 984, 985-86 (N.Y. 1917) (stating that "[i]t may be that a stipulated [interest] rate may be so excessive that the contract will, should the occasion arise, be adjudged unconscionable and invalid-a question we would approach with much circumspection").
Madden, 237 F.Supp.3d at 142, 144 (internal citations omitted).
The Madden court then surveyed New York federal court decisions, stating:
Since Manfra, there has been some confusion in the federal courts as to whether the criminal usury cap applies to defaulted obligations. On the one hand, some courts have held that the footnote in Manfra referred only to the civil usury cap. On the other hand, many federal courts have applied Manfra to bar a claim or defense for usury.
* * *
To the extent . . . [federal court] decisions contain statements about New York law that are at odds with New York state court decisions
like Emery, [which relied on Union Estates Co. and stated that "so long as an interest rate is not usurious . . ., the parties are . . . free to agree that the contract rate of interest shall increase upon default" the state court decisions control.
Emery v. Fishmarket Inn of Granite Springs, 1991 WL 100646 (N.Y.A.D. 2 Dept. May 31, 1991) (citations omitted).
Madden, 237 F.Supp.3d at 144-46 (internal citations omitted).
After surveying the federal and state case law, the Madden court ultimately concluded the following:
In sum, although the issue may ultimately have to be settled by the New York Court of Appeals, I conclude, based on Emery and its progeny, that New York's criminal usury cap applies to prevent a creditor from collecting interest above 25% on a defaulted debt.
Id. at 146
Other courts have followed Madden. See Bank of America v. David, 2023 WL 2606294, at *6 n.1 (N.Y. City Ct. Mar. 06, 2023) (stating that "a post-default interest rate still may not exceed the criminal usury limit of 25%"); Discover Bank v. Brown, 2023 WL 2606295, at *5 n.1 (N.Y. City Ct. Mar. 06, 2023) (stating that "a post-default interest rate still may not exceed the criminal usury limit of 25%"); Union Capital LLC v. Vape Holdings Inc., 2017 WL 1406278, at *8 (S.D.N.Y. Mar. 31, 2017) (stating that "the Court may not enforce a default interest rate that exceeded an overall effective interest rate of 25%"); LG Capital Funding, LLC v. Vapor Group, Inc., 2018 WL 3193209, at *3 (E.D.N.Y. June 28, 2018) ("conclud[ing] that the state criminal usury cap applies to default interest rates"). However, not all courts have found Madden to be persuasive.
See LG Capital Funding, LLC v. PositiveID Corporation, 2019 WL 3437973, at * 13 (E.D.N.Y. July 29, 2019); EMA Financial, LLC v. AIM Exploration, Inc., 2019 WL 689237, at *10 (S.D.N.Y. Feb. 19, 2019); Blue Citi, 338 F.Supp.3d at 336-37; LG Capital Funding, LLC v. One World Holding, Inc., 2018 WL 3135848, at *13 (E.D.N.Y. June 27, 2018).
This Court finds Madden and its progeny persuasive. Madden is consistent with New York's strong public policy against usury, as recently articulated by New York state courts:
[T]he modern conception of [New York's] usury laws focuses on the protection of persons in weak bargaining positions from being taken advantage of by those in much stronger bargaining positions. Without doubt, New York's voiding of usurious contracts "can be harsh," perhaps especially in comparison to other states' laws, but the penalty reflects the legislature's consistent condemnation of the "evils of usury". The forfeiture of interest and capital serves a strong deterrent effect-one the legislature has repeatedly affirmed.
Adar Bays, LLC v GeneSYS ID, 2021 N.Y. Slip Op. 05616, 5-6, 2021 WL 4777289 (N.Y. Oct. 14, 2021) (internal citations omitted); see also Samson Lending LLC v Greenfield Management LLC, 2023 WL 5691680 (N.Y. Sup. Ct. Sep. 05, 2023).
This policy extends to smaller businesses, like Debtor, where criminal usury is implicated. As recently explained, "New York usury statutes are a deeply rooted tradition designed to protect both individuals and corporations-especially insecure businesses in need of financial assistance- from the 'evils of usury'."
Samson Lending, 2023 WL 5691680, at *3 (quoting Seidel v. 18 East 17th Street Owners, 79 N.Y.2d 735, 740 (N.Y. 1992)).
Given New York's strong public policy against usury, it follows that those in weaker bargaining positions require the same protection from criminally usurious default interest rates as they need from criminally usurious non-default interest rates. And, WBL knows that its borrowers are in weak bargaining positions, as the loan agreement specifically acknowledges that the loan "is a higher cost loan than business loans which may be available through other sources." WBL takes this to an extreme, charging exorbitant interest, penalties, and fees, while also taking a first mortgage on Debtor's real property.
POC 13-1, p. 13, ¶ 1.
The Court does note that the loan at issue contains a provision that if the interest rate is deemed to exceed the maximum permitted by law, then (1) the interest rate will be reduced, (2) amounts paid in excess will be refunded, and (3) the loan obligation "shall be fulfilled to the limit of such validity as is permitted by law." However, under New York law, purported "usury savings clauses" do not protect an otherwise usurious loan.
POC 13-1, p. 20, ¶ 17(h).
See American E Group LLC v. Livewire Ergogenics Inc., 2020 WL 469312, at *8 (S.D.N.Y. Jan. 28, 2020); Samson Lending, 2023 WL 5691680, at *6.
To succeed on the defense of criminal usury, Debtor must prove that the lender: "(1) knowingly charged, took or received (2) annual interest exceeding 25% (3) on a loan or forbearance." "[T]here is a strong presumption against a finding of usurious intent and against a finding of usury. Therefore, [u]sury must be proved by clear evidence as to all its elements and will not be presumed."
In re Venture Mortg. Fund, L.P., 245 B.R. 460, 473 (Bankr. S.D.N.Y. 2000).
In re General American Communications Corp., 73 B.R. 887, 891 (S.D.N.Y. 1987) (quotation marks and internal citations omitted).
There is no dispute that the debt at issue is a loan, so the third element is easily met. The first two elements-that the lender knowingly charged, took or received annual interest exceeding 25%-"requires proof of the general intent to charge a rate in excess of the legal rate rather than the specific intent to violate the usury statute." With respect to intent:
Venture Mortg., 245 B.R. at 473-74 (citations omitted).
Usurious intent, an essential element of usury, which is embodied in the statutory requirement that an unlawful rate of interest be knowingly taken, is a question of fact. It is the prevailing view that where usury does not appear on the face of the note, usury is a question of fact. It has been properly observed: "[I]f the note or bond shows a rate of interest higher than the statutory lawful rate, it would be immaterial whether the lender actually intended to violate the law. His intent would be conclusively presumed." . . . [Thus,] it is settled that the voluntary taking or reservation of a greater interest or compensation for the loan or forbearance of money than that allowed by law is usurious . . ..
Freitas v. Geddes Sav. and Loan Ass'n, 63 N.Y.2d 254, 262 (N.Y. Oct. 25, 1984) (internal citations omitted).
Given the current state of New York law on the issue of whether post-default interest can be included in the calculation to determine if a loan charges a criminally usurious interest rate, the Court finds that a question of fact exists regarding Defendants' intent to knowingly charge interest in excess of 25%. While the interest demanded in the POC equates to an interest rate of 29.81%- well in excess of the criminal usury cap of 25%-the POC was filed prior to this Court's conclusion on the unsettled area of law that default interest is included when considering the defense of usury. As such, Defendants' intent is an issue of fact for trial.
However, this does not mean that if the Court finds that Defendants did not knowingly charge annual interest exceeding 25%, the Court will simply allow the 29.81% interest sought in the POC. The Court cannot allow interest at a rate exceeding 25%. This means that the maximum amount of pre-petition interest that the Court could allow is $70,342.47 (which would be based on a factual finding that the entire $650,000 was loaned). Thus, at a minimum, the POC is disallowed to the extent that the POC includes the excess $13,534.24 in interest ($83,876.71 in interest included in the POC, less the maximum amount of pre-petition interest that the Court could allow of $70,342.47). To this extent, the Court grants Debtor summary judgment as to the allowability of interest in excess of 25%, with the issues of the amount of the loan and intent being factual issues for trial.
C. Prepayment Premium
Next, Debtor argues that the POC should be disallowed to the extent of the Prepayment Premium, which consists of unmatured interest or the economic equivalent thereof. In making this argument, Debtor relies on 11 U.S.C. § 502(b)(2).
Pursuant to § 502(b)(2), since Debtor has objected to the POC, this Court must determine the amount of the claim as of the petition date and allow such claim, except to the extent such claim is for unmatured interest. Section 502(b)(2) also excludes the economic equivalent of unmatured interest. As explained by one court:
In re Ultra Petroleum Corp., 624 B.R. 178, 184 (Bankr.S.D.Tex. 2020) (citation omitted).
[T]he economic equivalent of interest must be the economic
equivalent of consideration for the use or forbearance of another's money accruing over time. A claim is the economic equivalent of unmatured interest if, in economic reality, it is the economic substance of unmatured interest. If it is the economic equivalent of interest, the claim must be disallowed regardless of the parties' labels.
Id. at 191 (internal citations omitted).
Debtor argues that the loan's Prepayment Premium of $431,937.70 is calculated based on funds never actually disbursed to Debtor (i.e., the Holdback Funds), and as such, the Prepayment Premium is the economic equivalent of unmatured interest. While Defendants dispute that the Prepayment Premium is considered interest, as opposed to liquidated damages, Defendants argue that even if it is interest, it has matured. Defendants point out that Debtor defaulted in August of 2023, and the loan was accelerated by October 2023-months prior to the petition date. Thus, Defendants argue, regardless of how the amount is characterized, it was due and owing pre-petition.
Doc. 11-1, p. 4, ¶ 12.
The Court agrees with Defendants that because the Prepayment Premium was triggered by the pre-petition default and loan acceleration, the Prepayment Premium may survive a § 502(b)(2) challenge. However, the Prepayment Premium must still be analyzed to determine whether it is an enforceable liquidated damages provision or an unenforceable penalty.
See, e.g., In re South Side House LLC, 2009 WL 8189266, at *8 (Bankr. E.D.N.Y. Nov. 12, 2009) (stating that "when a prepayment fee is claimed in bankruptcy by virtue of a pre-petition acceleration, such a provision will not be deemed to be unmatured interest under § 502(b)(2) because the lender's entitlement to such charge arose and matured pre-petition").
The Court in the case of In re Madison 92nd Street Associates LLC explained the law in New York regarding prepayment premiums:
472 B.R. 189 (Bankr. S.D.N.Y. 2012).
Prepayment premiums are generally enforceable under the New York common law "rule of perfect tender in time." This rule prohibits the prepayment of the loan under the rationale that the lender has the absolute right to receive the bargained for income
stream over the life of the loan. The prepayment premium is viewed as the price of the option exercisable by the borrower to prepay the loan and cut off the lender's income stream, and insures the lender against loss of the bargain if interest rates decline.
The lender that accelerates the loan following a default generally forfeits the right to a prepayment premium because the acceleration advances the maturity date, and by definition, the loan cannot be prepaid. Where, however, a clear and unambiguous clause requires the payment of the prepayment premium even after default and acceleration, the clause will be analyzed as a liquidated damages clause.
* * *
Whether a clause which prescribes liquidated damages is in fact an unenforceable penalty is a question of state law. A liquidated damages clause is valid under New York law if: (1) actual damages are difficult to determine, and (2) the sum is not "plainly disproportionate" to the possible loss. The enforceability of a liquidated damages provision must be decided based on the circumstances existing at the time the parties entered into their agreement.
The party seeking to avoid the liquidated damages clause bears the burden of proving that it is a penalty and must demonstrate either that the damages flowing from prepayment were readily ascertainable at the time the parties entered into the lending agreement or the prepayment premium is "conspicuously disproportionate" to the lender's foreseeable losses. This burden must be considered in light of the admonition that the historical distinction between liquidated damages and penalties has become increasingly difficult to justify, and courts should not interfere with the parties' agreement regarding liquidated damages "absent some persuasive justification."
Id. at 195-96 (internal citations omitted).
Here, the Prepayment Premium of $431,937.70 is "plainly disproportionate" to the possible loss if the amount of the loan is just the amounts disbursed-the closing costs of $43,711.62, property taxes of $29,472.94, and property insurance of $21,309.36 (totaling $94,493.92). However, as explained below, even assuming that the amount of the loan is $650,000, the record before the Court establishes that the Prepayment Premium of $431,937.70 is an unenforceable penalty as it is "plainly disproportionate" to the possible loss that the parties could have foreseen when they entered into the loan.
As previously stated, the Prepayment Premium applies in two scenarios. First, if Debtor prepaid the loan within the first twelve months and had not missed any payments, Debtor would have to pay a Prepayment Premium calculated as the amount of interest that would have been paid during the full twelve-month period ($145,849.09) less the amount of interest that Debtor had already paid. In such a situation, the Prepayment Premium appears to compensate WBL for losing three-years of interest that would have been due under the loan, while taking into account the fact that WBL would have use of its funds that it had lent earlier than expected. Thus, Debtor would be exercising an option to prepay the loan and cut off WBL's income stream, and the Prepayment Premium compensates WBL against the loss of the bargain if interest rates decline. This analysis of the purpose of the Prepayment Premium-to ensure that WBL had a guaranteed income stream during the first twelve months of the loan-is confirmed by the fact that there is no Prepayment Premium if Debtor prepaid the loan in full after twelve months, if Debtor had not missed any payments.
The Court makes no finding regarding whether the Prepayment Premium under this scenario is, in fact, an enforceable liquidated damages provision.
However, that is not the scenario at issue in this case. In the second scenario (applicable to this case), if Debtor prepaid the loan at any time but had previously missed a payment, Debtor would have to pay a Prepayment Premium calculated as the greater of: (1) 15% of the unpaid principal (which equals $97,500) and (2) the amount of interest that would have been paid during the full three-year loan period ($437,547.28) less the amount of interest that Debtor had already paid. Thus, by missing the first weekly interest payment, Debtor automatically would have to pay the full three-year amount of interest of $437,547.28 regardless of when Debtor repaid the loan. So, if Debtor missed the first payment and then wanted to pay off the loan the following week (and thus the loan would have been outstanding for 14 days), Debtor would be required to pay a total of $437,547.28 for interest and the Prepayment Premium.
Under the second scenario, the Prepayment Premium is a disguised penalty that penalizes the borrower for missing a single payment. This is true because if a borrower does not miss the first payment and then prepays the loan the following week, the Prepayment Premium plus interest is only $145,849.09. The only difference between the two examples is a missed payment, the consequence of which is that the Prepayment Premium almost triples. However, it cannot be stated that WBL's loss in the two examples (prepayment on week two with a missed payment and prepayment in week two without a missed payment) differs in any meaningful way that would justify almost tripling the Prepayment Premium.
Again, the Court makes no finding regarding whether the Prepayment Premium when the loan is repaid within the first twelve months and no payments have been missed is, in fact, an enforceable liquidated damages provision.
The purpose of liquidated damages provisions has been described as follows:
[A] liquidated damage provision is an estimate, made by the parties at the time they enter into their agreement, of the extent of the injury that would be sustained as a result of breach of the agreement. . . . Provisions for liquidated damage have value in those situations where it would be difficult, if not actually impossible, to calculate the amount of actual damage. . . . It is plain that a provision which requires, in the event of contractual breach, the payment of a sum of money grossly disproportionate to the amount of actual damages provides for penalty and is unenforceable. A liquidated damage provision has its basis in the principle of just compensation for loss. A clause which provides for an amount plainly disproportionate to real damage is not intended to provide fair compensation but[,] . . . in the event of default, would [cause the promisee to] reap a windfall well above actual harm sustained.
* * *
The rule is now well established. A contractual provision fixing damages in the event of breach will be sustained if the amount liquidated bears a reasonable proportion to the probable loss and the amount of actual loss is incapable or difficult of precise estimation.
If, however, the amount fixed is plainly or grossly disproportionate to the probable loss, the provision calls for a penalty and will not be enforced.
Truck Rent-A-Center v. Puritan Farms 2nd, 41 N.Y.2d 420, 424-25 (N.Y. 1977) (internal citations omitted).
Based on the above, when looking at the Prepayment Premium at the time that the parties entered into the loan and the possible prepayment scenarios that could occur, it is clear that the Prepayment Premium due when a payment is missed is not an estimate of hard-to-calculate damages, but instead, it is a penalty that is plainly disproportionate to the possible loss that the parties could have foreseen when they entered into the loan. Stated differently, the amount stipulated by the parties as damages via the Prepayment Premium when a payment has been missed does not bear a reasonable relationship to the amount of probable harm. This conclusion is consistent with other courts' findings that purported liquidated damages provisions were unenforceable penalties.
A liquidated damages provision to compensate WBL for losses resulting from a missed payment is unnecessary, because WBL has a mortgage on Debtor's property worth $2.4 million to secure its purported $650,000 loan.
See id. at 425.
See, e.g., Howard Johnson Intern. Inc. v. HBS Family, Inc., 1998 WL 411334, at *4 (S.D.N.Y. July 22, 1998) (stating that "a fixed sum liquidated damages provision that does not take into account the extent of probable damage at the time of default is not reasonable under New York law"); Gilad Realty Corp. v. Ripley Pitkin Ave., 48 A.D.2d 683, 683-84 (N.Y.A.D. 2 Dept. 1975) (concluding that the liquidated damages provision in a 21-year lease that provided that the defendant's failure to pay rent at any time resulted in an increase of $375 per month in the rent due for past and future rent payments was an unenforceable penalty, because it would result in the defendant paying over $91,000 for its failure to pay the $1,448.33 monthly rental payment due for the final six months of the lease); Vernitron Corp. v. CF 48 Associates, 104 A.D.2d 409, 409-10, (N.Y.A.D. 2 Dept. 1984) (concluding that the liquidated damages clause that provided for a sum equal to one year of rent for any default under the lease was an unenforceable penalty; noting "that the loss which might occur as a result of certain minor defaults under the lease (i.e., for a two-day delay in payment of rent) would be clearly disproportionate to the amount of liquidated damages").
For example, in the case of In re MarketXT Holdings Corp., EIF acted as a middleman for a transaction and "loaned" the debtor funds that were actually the proceeds of the debtor's own property from a third-party. Initially, the "loan" was for one year at 8% interest, but the terms changed to a four-year loan at 19% interest with a prepayment penalty equal to four years of interest at 19%. Under the revised terms, "the four-year 19% 'prepayment penalty' purported to afford [EIF] at least 76% of the value of the proceeds [loaned] . . . even if the 'loan' w[as] repaid immediately."
376 B.R. 390 (Bankr. S.D.N.Y. 2007).
See id. at 397.
See id.
See id. at 397 n.3.
The court analyzed the prepayment penalty to determine whether it was an enforceable liquidated damages provision and stated the following:
[E]ven if a riskier loan might justify a higher interest rate, a prepayment penalty is a liquidated damages clause designed to compensate a lender for costs incurred in connection with early payment on a long-term loan, resulting from the possibility that interest rates will be lower when the repaid funds are relent, or that the lender will not be able to rely on a stable flow of funds over a known period. The possibility that the "loan" to the Debtor was viewed as more risky does not provide any justification for extending its term from one year to four years and imposing an enormous penalty on the Debtor for repaying it. Examining the reasonableness of the revised provision in light of the circumstances at the time of its creation, and giving Defendants the benefit of every doubt, Defendants cannot justify a penalty that in effect charged the Debtor 76% of the principal amount of its own money if it repaid the putative loan after one day. This prepayment penalty was an unreasonable and unenforceable liquidated damages clause.Likewise, another example of a court finding a liquidated damages provision to be an unenforceable penalty is in the case of In re O. P. M. Leasing Services, Inc In that case, the debtor leased computer equipment to Revlon for a 37 month term, which would have ended on January 31, 1982. A provision of the lease provided that in the event the debtor failed to pay a monthly maintenance charge (and failed to cure within sixty days), Revlon had the right of reimbursement and could exercise an option to extend the lease term at a rental rate of one dollar per month for an additional five years (the "Dollar Option").
Id. at 417 (internal citations omitted).
23 B.R. 104 (Bankr. S.D.N.Y. 1982).
See id. at 107.
See id.at 108.
Around March of 1981, after Revlon learned that the debtor had failed to continue paying the monthly maintenance charges beginning around month twenty-four of the lease term, Revlon paid the monthly maintenance charges and exercised the Dollar Option to extend the lease for an additional five years for a total of $60. By September of 1982, the leased computer equipment was worth approximately $100,000, and by the end of the extended lease term, the computer equipment would be virtually worthless. Thus, by exercising the Dollar Option upon the debtor's failure to pay the monthly maintenance charges, Revlon was able to lease computer equipment worth $100,000 for an additional five years for a total cost of $60.
See id. at 109.
See id. at 108.
An issue before the court was whether the Dollar Option was an enforceable liquidated damages provision or an unenforceable penalty. In finding that the Dollar Option was an unenforceable penalty, the court explained:
See id. at 110.
The Dollar Option purports to give Revlon the right to extend [the lease] for 59 months in the event [the debtor] fails to pay any "maintenance charge" estimated at $3,350 per month. Thus, for one missed monthly payment, Revlon would have virtually free use of a machine which . . . [is] estimated as worth $100,000 for almost five years, the remainder of the equipment's useful life. This is plainly disproportionate to any potential loss, especially in view of its cumulation with Revlon's right to recover actual damages and demonstrates the penal nature of the Dollar Option.
* * *
Revlon's exercise of the Dollar Option would be totally unrelated to and unaffected by the timing and amount of the maintenance default and would reap a windfall on Revlon while causing [the debtor] to
suffer a penalty.
See id. at 112-113, 114 (footnote omitted).
Similarly, the court in LeRoy v. Sayers stated that a liquidated damages provision cannot cause a promisee to "realize a reward far beyond his actual loss." In that case, the court explained:
217 A.D.2d 63 (N.Y. 1 Dept. 1995).
Id. at 70.
[Defendant conceded that he] anticipated that the possible damages emanating from a breach [of a two-month summer lease for a Hamptons beach house] could vary substantially depending on when the breach occurred. A breach occurring early in the high rental season, where the chances of a rerental are good, as occurred here, might result in damages that are negligible. In arriving at a stipulated sum as liquidated damages, "[t]here must be some attempt to proportion . . . damages to the actual loss." Since the clause awarded the same exorbitant sum [$50,000] irrespective of the time of the breach and even in the instance where, concededly, the damages flowing from a breach and immediate rerental would be negligible, it constitutes a penalty and is unenforceable.
Id. at 70-71 (internal citation omitted).
Like the court found in LeRoy, there has been no attempt by Defendants to proportion the amount of the Prepayment Premium when a payment has been missed to the anticipated resulting loss.
Finally, the court in Chaifetz v. Schreiber found that a note that permitted prepayment without a penalty unless there was a default, in which case the borrower was required to pay all earned and unearned interest over the life of the loan, contained an unenforceable penalty. There, the court stated:
2003 WL 21738599 (E.D.N.Y. June 10, 2003).
Id. at *1-2.
The Note requires payment of the unearned interest in the event of the default in order to discourage the defendants from defaulting. The provision functions as a penalty for default and is not linked to an assessment of probable damages, which would, ultimately, easily be computed based on the interest accrued from the date of default. Accordingly, under New York law, the provision is unenforceable.
Id. at *2 (citations omitted).
Based on the above, this Court concludes that the Prepayment Premium is an unenforceable penalty. As a result, the Court grants Debtor summary judgment on Count I to the extent that Debtor objected to the POC to the extent that it includes the Prepayment Premium of $431,937.70.
To be clear, prepayment premiums, also known as make-whole premiums or yield maintenance premiums, are not per se unenforceable penalties. New York courts have found them to be enforceable liquidated damages clauses in cases where they reflect the parties' attempt to accurately estimate the amount of the lender's loss due to the loan being prepaid early. See, e.g., In re 1141 Realty Owner LLC, 598 B.R. 534 (Bankr. S.D.N.Y. 2019) (lender's proof of claim relating to a $25 million 10-year loan included a make-whole premium of $ 3.1 million); Wilmington Trust, National Association v. Winta Asset Management LLC, 2023 WL 9603893 (S.D.N.Y. Dec. 21, 2023), adopted by 2024 WL 1700032 (S.D.N.Y. April 18, 2024) (allowing a yield maintenance premium of $150,000 on a $15 million loan).
IV. Conclusion
There are several factual issues that preclude the Court from deciding Count I in its entirety. These factual issues include: (1) whether Angioli had actual or apparent authority to bind Debtor for the loan; (2) the amount that was loaned; and (3) whether Defendants knowingly charged annual interest exceeding 25%. Resolution of these factual issues is necessary to determine whether Debtor is bound by the loan and/or whether the loan is void ab initio.
Despite these factual issues, the Court concludes as a matter of law that the POC includes interest at a rate in excess of 25%. Thus, at a minimum, the POC is disallowed to the extent that the POC includes the excess $13,534.24 in interest.
Likewise, the Court concludes as a matter of law that the Prepayment Premium is an unenforceable penalty. As such, the POC is disallowed to the extent that it includes the Prepayment Premium of $431,937.70.
Based on the above, the maximum amount that might be allowable for the POC is $164,906.39 ($610,378.33 POC, less $13,534.24 of excess interest, less the Prepayment Premium of $431,937.70).
Accordingly, it is ORDERED that Debtor-Plaintiff s Motion for Summary Judgment as to Count I (Doc. 6) is GRANTED to the extent that the Court finds that interest of more than 25% will not be allowed, and the Prepayment Premium is an unenforceable penalty that will not be allowed. Otherwise, the motion is DENIED.
Service of this Order other than by CM/ECF is not required. Local Rule 9013-3(b).