Opinion
No. CV-07-4023063 S
August 29, 2008
MEMORANDUM OF DECISION ON PLAINTIFF'S MOTION FOR SUMMARY JUDGMENT
This matter is before the court on plaintiff's motion for summary judgment. At issue is the enforceability of a prepayment premium provision contained in a commercial loan contract between the plaintiff medical group and the defendant bank. On November 9, 2007, the plaintiff, Ridgefield Surgical Center, LLC, commenced this action against the defendant, People's United Bank. In its three-count complaint, the plaintiff alleges breach of contract, unjust enrichment and also seeks a declaratory judgment.
The dispute centers on the plaintiff's fulfillment of a prepayment premium provision of the commercial loan agreement it entered into with the defendant. The plaintiff has moved for summary judgment on the ground that the prepayment premium it paid to the bank under protest constitutes an illegal and invalid penalty as a matter of law. The defendant bank contends that such prepayment penalties are generally enforceable as a matter of law, and that the contested provision is specifically enforceable. For the reasons stated herein, the court denies the motion for summary judgment.
Summary judgment "shall be rendered forthwith if the pleadings, affidavits and any other proof submitted show that there is no genuine issue as to any material fact and that the moving party is entitled to judgment as a matter of law." Practice Book § 17-49. "[I]n seeking summary judgment, it is the movant who has the burden of showing the nonexistence of any issue of fact. The courts are in entire agreement that the moving party for summary judgment has the burden of showing the absence of any genuine issue as to all the material facts, which, under applicable principles of substantive law, [entitle] him to a judgment as a matter of law. The courts hold the movant to a strict standard. To satisfy his burden the movant must make a showing that it is quite clear what the truth is, and that excludes any real doubt as to the existence of any genuine issue of material fact . . . As the burden of proof is on the movant, the evidence must be viewed in the light most favorable to the opponent." Socha v. Bordeau, 277 Conn. 579, 585-86, 893 A.2d 422 (2006).
"A material fact is a fact that will make a difference in the outcome of the case . . . Once the moving party has presented evidence in support of the motion for summary judgment, the opposing party must present evidence that demonstrates the existence of some disputed factual issue . . . It is not enough, however, for the opposing party merely to assert the existence of such a disputed issue. Mere assertions of fact . . . are insufficient to establish the existence of a material fact and, therefore, cannot refute evidence properly presented to the court." (Internal quotation marks omitted.) Lombard v. Edward J. Peters, Jr., P.C., 79 Conn.App. 290, 295, 749 A.2d 623 (2003).
The plaintiff moves for summary judgment on the ground there are no genuine issues of material fact and it is entitled to judgment as a matter of law. It argues that the prepayment premiums that it paid under the commercial loan contract were illegal and invalid penalties, rather than enforceable liquidated damages. The plaintiff acknowledges that prepayment penalties are generally enforceable under Connecticut law if they are a reasonable estimate of actual damages sustained from prepayment. In this case, however, the plaintiff claims that the prepayment premiums are unreasonable, because the damages which they are typically designed to capture have already been accounted for in a separate damages provision in the contract entitled the "Make Whole Fee."
Plaintiff contends that the provision in question fails all three of Connecticut's liquidated damage conditions and therefore it constitutes an unenforceable penalty. In response, the defendant counters that a genuine issue of material fact does exist, and that therefore summary judgment is not appropriate. The defendant maintains that the prepayment premium in this case is an enforceable liquidated damages clause, rather than an unenforceable penalty. The defendant concedes that there are limitations on a party's right to receive prepayment premiums under the law, but asserts that none of those limitations exist in this case. The defendant claims that it has a "legitimate independent basis for the Prepayment Premium as well as the Make Whole Fee."
There is scant case law in Connecticut addressing the enforceability of prepayment premium clauses in loan agreements. Both parties, however, acknowledge the general validity of these types of provisions and cite the Superior Court case of Eastern Savings Bank, FSB v. Munson, 50 Conn.Sup. 374, 932 A.2d 1079 (2007) [ 43 Conn. L. Rptr. 354]. In that case, the trial court held that Connecticut generally "recognized the legal validity of prepayment penalties in mortgages. They are not against public policy . . . or in violation of the Connecticut Unfair Trade practice Act . . . They are specifically allowed, although limited, in the Connecticut Abusive Home Loan Lending Practices Act." (Citations omitted.) Id., 376. In addition, both parties acknowledge that limitations on the enforceability of such provisions exist under the law. "The rationale for enforcing prepayment premiums rests on the recognition that such premiums serve as compensation to the lender for the losses incurred by the lender when it receives prepayment of its loan earlier than originally planned." Northwest Bank of Minnesota v. Blair Road Associates, 252 F.Sup.2d 86, 96 (D.N.J. 2003); see also J. Murray, " Prepayment Premiums: A Bankruptcy Court Analysis of Reasonableness and Liquidated Damages, 105 Com.L.J. 217, 222 (2000) ("[s]ome bankruptcy courts have taken the position that a prepayment premium must reflect the actual damages incurred by the secured party and that, absent a showing of actual and demonstrable harm, the premium should be disallowed as a windfall at the expense of unsecured creditors").
Alternatively, courts have asked "[s]hould a prepayment penalty be considered interest or is it . . . a sum representing a charge for some service provided by the plaintiff or finance charges? . . . [O]ther courts have found that a prepayment premium is not interest at all because it is not compensation for the use of money but a charge for the option or privilege of prepayment, and that such a prepayment premium is enforceable even when the lender accelerates the debt, so long as the loan documents clearly provide for the premium. Parker Plaza West Partners v. UNUM Pension and Ins., 941 F.2d 349 (5th Cir. 1991) (applying Texas law); Resolution Trust Corp. v. Minassian, 777 F.Sup. 385 (D.N.J. 1991) (applying New Jersey law). In other words, it is . . . a sum representing a benefit that the borrower otherwise would not be entitled to." (Citation omitted; internal quotation marks omitted.) Northwest Bank of Minnesota v. Blair Road Associates, supra, 252 F.Sup.2d 96; see also West Raleigh Group v. Massachusetts Mutual Life Ins. Co., 809 F.Sup. 384, 391 (E.D.N.C. 1992) ("[t]he prepayment penalty or premium is the bargained-for consideration for the option to prepay, and as such it is enforceable as a matter of contract law and not as a measure of damages").
Although there is no case directly on point addressing whether Connecticut law treats such a provision as compensation for losses incurred or as bargained-for consideration for the option to prepay, the Appellate Court provided guidance in CMG Realty of Connecticut, Inc. v. Colonnade One Ltd Partnership, 36 Conn.App. 653, 665, 653 A.2d 207 (1995). In that case, the court was "unpersuaded by the plaintiff's claim that termination of the contract was a right that the defendant bargained for in exchange for the payment of [the termination fee." Id. Rather, the court made clear that "[t]he trial court properly concluded that the termination fee was a penalty as it was not related to any damages that the plaintiff would suffer in the event of a breach by the defendants." Id., 664. This court interprets this opinion in light of the instant case, and rejects the "bargained-for consideration" understanding of prepayment premiums, and adopts the aforementioned "compensation to the lender" rationale.
Generally, "[i]n those cases where a court addresse[s] a loan clause which required payment of a premium as a condition of allowing a prepayment, the court usually focused on the nature of the prepayment in determining the enforceability of the clause." M. Phillips T. Homburger, "What You See Is Not Always What You Get: The Enforceability of Loan Pre-Payment Penalties," 23 J. Marshall L. Rev. 65, 68 (1989). "In reaching its conclusion that the prepayment clause was enforceable, [courts have] applied principles of law often used in determining the enforceability of liquidated damages provisions." Id., 69; see, e.g., In re Schaumburg Hotel Owner Limited Partnership, 97 B.R. 943, 953-54 (Bankr.N.D.Ill. 1989) (determining the enforceability of a prepayment premium by applying a liquidated damages analysis). Accepting this approach, this court must apply Connecticut law pertaining to liquidated damages to determine the validity of the prepayment premium clause in this case.
The question of enforceability typically involves an analysis of the effect of acceleration of the debt instrument. See, e.g., FSB v. Munson, supra, 50 Conn.Sup. 375 ("[t]he short answer as to whether a prepayment penalty can be included in the mortgage debt in a foreclosure proceeding is that it depends on the language of the prepayment penalty provision in the note and whether the mortgagor defaulted with the intent to avoid the penalty"). There is a split of authority on this issue. Generally, "[i]n determining whether to enforce a prepayment premium, courts usually consider whether the prepayment was voluntary, in which case prepayment premiums of a reasonable amount usually are allowed, or involuntary, in which event prepayment premiums usually are denied and the issue of reasonableness of the amount of the premium is not considered." M. Phillips T. Homburger, supra, 23 J. Marshall L. Rev. 79. "Courts have most often refused to enforce prepayment fees in situations in which the prepayment was not under the control of the borrower. For example, a note may be paid early because of condemnation, via eminent domain, of the property that secures the note. Similarly, a note may be paid early by insurance proceeds following the destruction of the collateral securing the note. Some courts, applying this lack of control reasoning have refused to enforce prepayment fees when prepayment is caused by acceleration, especially when the acceleration is at the discretion of the lender." G. Nation III, " Prepayment fees in Commercial Promissory Notes: Applicability to Payments Made Because of Acceleration," 72 Tenn. L. Rev. 613, 619 (2005). Other courts, including the Superior Court, have held that "the provision in the promissory note that specifically required a prepayment premium in case of acceleration upon default did not violate public policy and was enforceable." FSB v. Munson, supra, 50 Conn.Sup. 381. This court adopts the reasoning of Munson, and finds this prepayment premium to be enforceable regardless of acceleration because the terms of the contract expressly contemplate this possibility.
"As a general rule parties can contract to liquidate their damages, and courts have not interfered with such contracts where the proof of damages would be uncertain or difficult and the amount agreed upon is reasonably commensurate with the extent of the injury." King Motors, Inc. v. Delfino, 136 Conn. 496, 498, 72 A.2d 233 (1950). It is well settled that "case law recognizes that contracting parties may decide on a specified monetary remedy for an unexcused failure to perform a contractual obligation." Bellemare v. Wachovia Mortgage Corp., 94 Conn.App. 593, 611-12, 894 A.2d 335, cert. denied, 280 Conn. 901, 907 A.2d 88, cert. granted on other grounds, 280 Conn. 901, 907 A.2d 88 (2006), aff'd, CT Page 14300 284 Conn. 193, 931 A.2d 916 (2007). The Supreme Court has made it clear, however, that "[i]t is equally well settled that a contract provision which imposes a penalty for breach of contract is invalid, but a provision which allows liquidated damages for breach of contract is enforceable if certain conditions are satisfied." Hanson Development Co. v. East Great Plains Shopping Center, Inc., 195 Conn. 60, 64, 485 A.2d 1296 (1985). Nevertheless, courts recognize that "[t]he principle that agreements contrary to public policy are void should be applied with caution and only in cases plainly within the reasons on which that doctrine rests; and it is the general rule . . . that competent persons shall have the utmost liberty of contracting and that their agreements voluntarily and fairly made shall be held valid and enforced in the courts." (Citations omitted; internal quotation marks omitted.) Williams v. Vista Vestra, Inc., 178 Conn. 323, 328, 422 A.2d 274 (1979).
"A contractual provision for a penalty is one the prime purpose of which is to prevent a breach of the contract by holding over the head of a contracting party the threat of punishment for a breach . . . A provision for liquidated damages, on the other hand, is one the real purpose of which is to fix fair compensation to the injured party for a breach of the contract. In determining whether any particular provision is for liquidated damages or for a penalty, the courts are not controlled by the fact that the phrase `liquidated damages' or the word `penalty' is used. Rather, that which is determinative of the question is the intention of the parties to the contract. Accordingly, such a provision is ordinarily to be construed as one for liquidated damages if three conditions are satisfied: (1) The damage which was to be expected as a result of a breach of the contract was uncertain in amount or difficult to prove; (2) there was an intent on the part of the parties to liquidate damages in advance; and (3) the amount stipulated was reasonable in the sense that it was not greatly disproportionate to the amount of the damages which, as the parties looked forward, seemed to be presumable loss which would be sustained by the contractee in the event of a breach of the contract." (Internal quotation marks omitted.) American Car Rental, Inc. v. Commissioner of Consumer Protection, 273 Conn. 296, 306-07, 869 A.2d 1198 (2005).
The Appellate Court has held that when other provisions have "fully compensated the [defendant] . . . [the plaintiffs] have carried their burden of showing that the payment of an additional . . . termination fee would be nothing more than a penalty." CMG Realty of Connecticut, Inc. v. Colonnade One Ltd Partnership, 36 Conn.App. 653, 668-69, 653 A.2d 207 (1995). The plaintiff claims that none of the three aforementioned conditions are satisfied. Specifically, the plaintiff argues that a "benefit of the bargain expense," which is the difference between the profit the bank expects to earn under the terms of the loan and the profit it could earn if the prepaid funds are loaned to another borrower, is the most common type of damage that banks protect against with prepayment premiums. The plaintiff contends that since the "Make Whole Fee" already captures this expense, the prepayment premium in this case is superfluous and unreasonable.
"Prepayment penalties are . . . recognized to serve an important commercial purpose. They lock in the financial yield for which the mortgagee bargained at the inception of the transaction and further compensate the mortgagee for losses that may adhere in a payment prior to maturity. Those losses include the administrative and legal costs of making a new loan and in some cases, additional tax liability . . . A number of cases confirm the justification of prepayment penalties to compensate lenders for the loss of the bargain if the loan is paid before a specified period of time." (Citation omitted, internal quotation marks omitted.) Eastern Savings Bank FSB v. Munson, supra, 50 Conn.Sup. 376-77; see also U.S. v. Harris, 246 F.3d 566, 573 (6th Cir. 2001) ("[t]he clear purpose for a prepayment penalty is to compensate the lender for the risk that market rates of interest at the time of prepayment might be lower than the rate of the loan being prepaid. Such a provision would compensate the lender for anticipated interest that would not be received if the loan were paid prematurely . . . Among other things, a prepayment premium insures the lender against loss of his bargain if interest rates decline").
The defendant bank submitted the affidavit of its vice president, Timothy Doheny. Doheny states that the prepayment premium provision has two purposes: to cover the administrative costs of generating the plaintiff's loan, and to protect the defendant against underwriting risks and the possibility that plaintiff would seek an early refinance. Doheny further contends that the "Make Whole Provision" merely protects the defendant from any economic loss in the event of prepayment, an arguably separate concern than the costs which the prepayment premium was designed to recapture.
"A prepayment premium also may be expressed as an approximation of the unrealized interest the lender will forfeit as a result of the prepayment. This approximation is often calculated by determining the present value of the difference between the interest payments the lender would have received pursuant to the loan but for the prepayment and the product of the amount of principal prepaid multiplied by the market interest rate prevailing at the time of the prepayment. Theoretically, the lender may reinvest the principal upon prepayment and the present value of the difference between its anticipated return under the prepaid note and its actual return at the market rate should represent the lender's direct damages as a result of the prepayment." M. Phillips T. Homburger, supra, 23 J. Marshall L. Rev. 67. This purpose, commonly associated with a prepayment premium, is what the plaintiff alleges both of the aforementioned damage clauses capture. However, the "Make Whole Fee" in this case is not the difference between the interest payments the lender would have received and the principal prepaid, multiplied by the market interest rate at the time of prepayment. Rather, the "Make Whole Fee" calculates the difference between the principal prepaid, multiplied by the market interest rate at the time of prepayment and the cost of funds rate. Thus, the "Make Whole Fee" arguably does not constitute double damages, but could be found to be compensation to the defendant for only one part of the actual damages that it may have incurred.
Section 2.20(f) of the parties' agreement, dated May 30, 2006, provides:
Make Whole Fee on Certain Prepayments of Leasehold Improvements Loans and Equipment Loans. Notwithstanding anything contained herein to the contrary, if at any time that all, or a portion of, a Leasehold Improvements Loan or an Equipment Loan which is subject to a Permanent Period Fixed Rate (Leasehold Loans) or Permanent Period Fixed Rate (Equipment Loans) is prepaid, then in addition to the applicable prepayment premium, if any, the Borrower will also pay to the Bank on the applicable prepayment date an amount equal to any Net Loss (as defined below) that the Bank sustains or incurs as a result of such prepayment.
As used herein, the term "Net Loss" means the Discounted Cost of Funds differential (defined below).
The "Discounted Cost of Funds Differential" shall be computed by the Bank as follows:
(A) The Bank shall first determine the Cost of Funds Rate.
(B) The Bank shall then calculate the monthly interest that would be earned on the principal amount of the Loan being prepaid at the Cost of Funds Rate for each month remaining until the last day of then Permanent Period (the "Termination Date"). The result is the "Monthly Cost of Funds Payment."
(C) The Bank shall then calculate the monthly interest that would be earned by reinvesting the principal portion of the amount being prepaid at the Reinvestment Rate (defined below) for each month remaining until the Termination Date. The result is the "Monthly Reinvestment Payment." The "Reinvestment Rate" shall mean the rate identified by the Bank, as of the date the Bank receives the prepayment notice, as the rate available to the Bank and other money center banks doing business in Connecticut (as published in the applicable Federal Reserve statistical release designated by the Bank) for the investment in U.S. Treasury Obligations ("Treasury Obligations") equal to the principal amount prepaid with maturities closest to, or coterminous with, the Termination Date. If, for any reason, a quotation is unavailable for such date, quotations for the next preceding date for which such quotations are available shall be used. If the Bank identifies more than one Treasury Obligation having the same maturity date, the Treasury Obligation having a coupon interest rate closet to the original Cost of Funds Rate shall be employed.
(D) Each Monthly Reinvestment Payment shall then be subtracted from the corresponding Monthly Cost of Funds Payment. The result, if positive, is the "Monthly Payment Differential." The Monthly Payment Differential shall in no event be less than zero.
(E) Each Monthly Payment Differential from the prepayment date to the Termination Date shall then be discounted to present value at the Reinvestment Rate on a monthly basis. The result is the "Discounted Monthly Payment Differential."
(F) All of the Discounted Monthly Payment Differential amounts shall then be added together and such aggregated amount shall constitute the Discounted Cost of Funds Differential.
However, in all events the Borrower shall be responsible, in addition to the Prepayment Fee, for the payment of any administrative costs incurred by the Bank in connection with such prepayment. If the Loan shall be accelerated for any reason whatsoever, the applicable Prepayment Fee in effect as of the date of such acceleration shall be paid. All partial prepayments of principal shall be accompanied by the applied first to the payment of unpaid late charges, then to accrued and unpaid interest, and the balance on account of the unpaid principal in the inverse order of maturity. Such partial prepayments shall not affect the Borrower's obligation to make the regular installments required hereunder until the Loan is fully paid.
Section 1.01 of the parties' agreement, dated May 30, 2006, provides in relevant part:
"Cost of Funds Rate" means, as of the commencement of the Permanent Period, a per annum rate of interest equal to the projected wholesale cost to the Bank of borrowing funds for the period of time commencing on such date and continuing to, but not including, the end of the applicable period, as the case may be, as such projected cost is (a) determined at such time by the Bank in the exercise of its reasonable judgment based upon rate information provided by funding sources ordinarily utilized by the Bank and which the Bank considers to be reasonable available to the Bank on the date of determination, and (b) made generally known by the Bank to the Bank's lending staff from time to time. By way of example only, types of funding sources the Bank has used include borrowings from the Federal Home Loan Bark of Boston, repurchase agreements and the federal funds, but the Bank's source of funding may change at any time without prior notice. The Bank's determination of the Cost of Funds Rate shall be conclusive and final, absent manifest error.
In his affidavit, Doheny states, "the inclusion of any given loan package of a `Make Whole Provision' does not necessarily mean that the borrower will have to pay money to the bank upon the early prepayment of a fixed rate loan." He further states that, "[t]he matter at hand is a classic example of a situation where the `Make Whole Provision' was not applicable and was not implemented to borrower's . . . detriment or to the Bank's benefit."
Therefore, because a genuine issue of material fact exists as to the reasonableness of the prepayment premium in conjunction with the "Make Whole Fee," plaintiff's motion for summary judgment is denied.
It is unclear whether the percentage specified in the prepayment premium provision yields a reasonable amount of damages, considering the two identified purposes of the clause. For the purposes of this motion for summary judgment, however, it "is appropriate only if a fair and reasonable person could conclude only one way . . . [A] summary disposition . . . should be on evidence which a jury would not be at liberty to disbelieve and which would require a directed verdict for the moving party . . . [A] directed verdict may be rendered only where, on the evidence viewed in the light most favorable to the nonmovant, the trier of fact could not reasonably reach any other conclusion than that embodied in the verdict as directed." (Citations omitted; emphasis in original; internal quotation marks omitted.) Dugan v. Mobile Medical Testing Services, Inc., 265 Conn. 791, 815, 830 A.2d 752 (2003). Thus, the prepayment premium, viewed in a light most favorable to the defendant, yields a reasonable amount considering the risk and administrative costs specified by the defendant.
SO ORDERED,