LHD Realty Corp., Matter of

Decision Date01 February 1984
Docket NumberNo. 82-2591,82-2591
Citation726 F.2d 327
PartiesIn the Matter of LHD REALTY CORPORATION, Debtor. Appeal of NATIONAL LIFE INSURANCE COMPANY.
CourtU.S. Court of Appeals — Seventh Circuit

Bruce A. Cordingley, Ice, Miller, Donadio & Ryan, Indianapolis, Ind., for appellant.

Stephen R. Buschmann, Buschmann, Carr & Meyer, Indianapolis, Ind., for appellee.

Before WOOD and CUDAHY, Circuit Judges, and WEIGEL, Senior District Judge. *

CUDAHY, Circuit Judge.

This appeal primarily involves a contest over a mortgage holder's right to receive a stipulated premium in exchange for accepting a borrower's repayment of a loan before maturity. The dispute is complicated somewhat by the fact that at the time of the prepayment the borrower was in a Chapter 11 bankruptcy proceeding. The bankruptcy court held that the mortgage holder was entitled to the prepayment premium, but the district court reversed. Because we believe that in the particular circumstances of this case the holder's right to a prepayment premium was not triggered, we affirm.

This case also involves a question about the holder's right to certain late payment charges. On this issue we reverse the district court's denial of the charges and remand.

I.

Appellant National Life Insurance Company ("National") was the assignee of a promissory note and mortgage in the principal amount of $775,000. The note was secured by the mortgage on an office building and parking garage in Indianapolis known as the "1800 Building." Appellee LHD Realty Corporation ("LHD") is a real estate management and investment company which acquired the 1800 Building in 1972 and assumed the note and the mortgage on the building which secured the note. Repayment of the promissory note was to be made in monthly installments over a period of fifteen years. The note provided that, if the loan was paid before maturity, the holder was entitled to a prepayment premium. 1

On June 13, 1980, LHD filed a voluntary petition under Chapter 11 of the Bankruptcy Reform Act of 1978, 11 U.S.C. Sec. 101 et seq. (the "Bankruptcy Code"), and since then has been operating its business and managing its property as a debtor in possession. Between July 1980 and April 1981, LHD made its monthly mortgage payments to National, although the payments were late each month. Since the April 1981 payment, however, LHD has not made any mortgage payments to National.

On August 26, 1981, with four monthly payments overdue, National filed in the bankruptcy court a request for relief from the automatic stay of proceedings against LHD provided by 11 U.S.C. Sec. 362. National stated in its complaint for relief that

[i]t is obvious there is no reasonable likelihood of rehabilitating the ailing Debtor.... A continued delay in allowing [National] to foreclose its lien will cause obvious irreparable harm to [National] because of the lack of adequate protection.

National therefore asked the bankruptcy court to allow it "to proceed with foreclosure of its lien" or to dismiss the bankruptcy action or to convert the Chapter 11 proceeding to a Chapter 7 liquidation, whereupon the 1800 Building would be sold at public auction.

On September 10, 1981, shortly after National filed its complaint for relief from the stay, LHD filed an application with the bankruptcy court seeking authority to employ a realtor to list the 1800 Building for sale. The application was approved and LHD found a buyer. On December 8, 1981, LHD filed with the bankruptcy court a complaint to sell the 1800 Building.

On December 15, 1981, there was a preliminary hearing on National's request for relief from the stay. National argued that the building income was not sufficient to support the existing debt and that the owner's equity in the building, which protected the secured lender, was decreasing. National then stated,

Therefore, your Honor, we think that this stay should be released and Plaintiffs have an opportunity to proceed with foreclosure, which we would suggest is still going to take seven or eight months, ... and until such time as we would then have a sheriff's sale, which would at minimum have to go to eight or nine months from now, the estate would have the opportunity to redeem it by basically paying the Plaintiff off.

Transcript of Proceedings of December 15, 1981 at 42-43 (emphasis supplied). In its trial brief National stated that, if it was relieved from the stay, it would "proceed to file a state action to foreclose its mortgage." In closing argument National summarized its position: "so we would again ask that this either be converted to a Chapter 7 and dismissed, or the stay be released as we don't have adequate protection." Id. at 66.

On December 18, 1981, the bankruptcy court issued its decision denying preliminarily the relief sought by National. The court based its decision not to lift the stay or dismiss or convert the proceeding on a finding that:

There is reasonable cause to believe that: the offer made by the prospective purchaser is valid; the purchaser is making a good faith effort to obtain financing; and, the proposed purchase price of $975,000.00 represents the fair market value of the property.

As discussed earlier, the total amount owing to creditors on the 1800 Building is approximately $634,000.00.... [S]uch surplus or equity in the property [$341,000] clearly shows that [National] is adequately protected.

Entry on Complaint for Relief from Stay at 3. The bankruptcy court then scheduled a final hearing on the relief request to be held thirty days later, on January 18, 1982.

On December 23, 1981, National filed its response to LHD's motion for permission to sell the 1800 Building. National asked for payment in full or a lien on the proceeds until paid, with the proceeds being held in a restricted account controlled by the court.

On January 15, 1982, the bankruptcy court issued its decision permitting LHD to sell the 1800 Building. The court's order provided that proceeds from the sale were to be retained and segregated by the debtor until the allowed liens and claims were paid.

On January 18, 1982, the bankruptcy court held the final hearing on National's request to be relieved from the stay. National argued again that it was not adequately protected and that it "need[ed] to basically proceed to realize our collateral." Transcript of Proceedings of January 18, 1982 at 73. The bankruptcy court, however, did not issue a final decision on National's request and it has since become moot.

II.

The parties agree that prepayment premiums serve a valid purpose in compensating at least in part for the anticipated interest a lender will not receive if a loan is paid off prematurely. Among other things, a prepayment premium insures the lender against loss of his bargain if interest rates decline. Accordingly, reasonable prepayment premiums are enforceable. See generally Annot., 86 A.L.R.3d 599 (1978); Annot., 75 A.L.R.2d 1265 (1961). 2

There are, however, some limitations upon the right to receive a prepayment premium. For one, the lender 3 loses its right to a premium when it elects to accelerate the debt. Slevin Container Corp. v. Provident Federal Savings & Loan Ass'n, 98 Ill.App.3d 646, 54 Ill.Dec. 189, 424 N.E.2d 939 (1981). This is so because acceleration, by definition, advances the maturity date of the debt so that payment thereafter is not prepayment but instead is payment made after maturity. 4 For another, courts infer an exception when a mortgage upon the property being condemned is satisfied by a government exercising its power of eminent domain. Jala Corp. v. Berkeley Savings & Loan, 104 N.J.Super. 394, 250 A.2d 150 (1969). Finally, courts infer an exception when payment results from destruction of the mortgaged property through an insured-against casualty such as a fire. Chestnut Corp. v. Bankers Bond & Mortgage Co., 395 Pa. 153, 149 A.2d 48 (1959). 5

We think that the case before us falls within the acceleration exception. The contract between National and LHD authorized National, "without notice, [to] declare the remainder of the debt at once due and payable." When a lender has the option to accelerate, " '[i]t is only necessary that the mortgagee show an unmistakeable intention to exercise the option, and this may be done by taking steps for foreclosure, filing foreclosure suit, sale pursuant to the mortgage, or advertisement of the property for sale pursuant to the terms of the mortgage.' " Rosenthal, The Role of Courts of Equity in Preventing Acceleration Predicated Upon a Mortgagor's Inadvertent Default, 22 SYRACUSE L.REV. 897, 899 n. 8 (1971) (quoting from 2 L. Jones, MORTGAGES Sec. 1512 (8th ed. 1928)) (emphasis supplied). 446 West 44th St., Inc. v. Riverland Holding Corp., 267 App.Div. 135, 44 N.Y.S.2d 766, 768 (1943) (election to accelerate "must consist either of notice of election to the mortgagor or of some unequivocal overt act manifesting an election....") (citation omitted).

The point is, we think, that a lender may abandon or waive its claim to interest payable over a period of years and to what amounts to insurance against a decline in interest rates. Thus, the lender, by its acts, may establish that it prefers accelerated payment to the opportunity to earn interest over a period of years. It is not appropriate, under these circumstances, for the lender to receive a prepayment premium in lieu of the interest foregone since it has voluntarily waived the unpaid interest in the expectation of accelerated payment of the remaining principal.

Thus, we think National exercised its option to accelerate no later than August 26, 1981, when it filed its request for relief from the automatic stay. National told the bankruptcy court that "it is obvious there is no reasonable likelihood of rehabilitating the ailing Debtor [LHD]" and asked the bankruptcy court to allow it to "proceed with foreclosure" or to dismiss or convert the Chapter 11 proce...

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