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The treatment of prepayment premiums in bankruptcy has gained substantial attention in several recent bankruptcy cases. In some sense, seeking allowance of a prepayment premium is a “good problem to have” from the lender's viewpoint, because in most bankruptcy cases, lenders are facing a substantial write-down on their prepetition loans. But in a situation where the borrower has the funds to repay the loan, there is frequently a dispute between lenders and unsecured creditors or equityholders who are looking at less than a full recovery on their claims.
From the lender's perspective, prepayment of a loan can detrimentally impact its expected yield by eliminating expected interest payments. Many lenders view the loan facilities that they extend to borrowers as a long-term investment with income certainty. Financing agreements frequently contain “make-whole” or prepayment fees to protect a lender's right to the yield for which it contracted.
The prepayment fee is a component of the overall package agreed upon by a lender and a borrower at the time that they are negotiating the term sheet for the credit facility. Prepayment fee provisions typically state that the borrower must make a lump-sum payment to the lender at the time that the borrower prepays all or any portion of a loan. In the current competitive lending environment, lenders find it challenging to replace borrowers that have refinanced their loans with similarly situated companies at equivalent pricing, and place value on the prepayment fee. A borrower that agrees to a prepayment fee should understand that it needs to calculate the incremental cost of the prepayment fee at the time that it is contemplating a repricing or refinancing transaction and determine whether the net savings from the proposed transaction will be greater than the amount of the prepayment fees and other costs of that transaction.
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