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Prepayment Premiums and Make-Whole Payments
Many loan agreements include clauses that permit borrowers to repay debt prior to the maturity date only if they make additional payments that are typically referred to as “prepayment premiums” or “make-whole payments.” The purpose of such prepayment premiums is to compensate lenders for what would otherwise be the loss of their bargained-for yields for the scheduled lives of their loans. Prepayment premiums are usually either based on a fixed fee, such as a percentage of the principal balance at the time of prepayment, or a yield maintenance formula that approximates the lenders' damages in the event of prepayment.
In the bankruptcy context, a prepayment premium will rarely be triggered by the debtor's voluntary prepayment of debt. Instead, usually the debtor will have defaulted and the debt will have been accelerated prior to bankruptcy, or the debt will have automatically accelerated due to the bankruptcy filing.
In these circumstances, to be enforceable, the loan documents must contain clear and unambiguous language requiring the prepayment premium upon acceleration. The majority of courts have held that prepayment premiums are not “unmatured interest” and may constitute recoverable liquidated damages if they satisfy the applicable state law test for enforcement, including in many states if the prepayment premium bears a reasonable relationship to the creditor's actual damages caused by the debtor's early repayment of the debt. Many courts also consider whether the prepayment premium is “reasonable” under Section 506(b) of the Bankruptcy Code.
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