By: Julia M. Wei, Esq.
Lenders may not be scrutinizing their loan documents as closely as borrowers are these days. Certainly, private lender Hyman Levy had a rude awakening when the appellate court concluded Levy was NOT entitled to default interest when the borrower did not make the balloon payment on a loan of $2.7M.
Mr. Levy, a philanthropist, made a $2.7M loan to the JCC at a rate of 5%. The loan was secured by the property where the JCC was operating its facilities. The note had language commonly seen in notes, such as an acceleration clause. For example, if the borrower defaulted, or had sold or otherwise transferred the property without lender approval, the entire amount of the loan would become due immediately. (The provision is also referred to sometimes as a “due on sale” or “due on encumbrance” clause.)
In that same paragraph as the acceleration clause, the note allowed for default interest at a rate of 11.25%, which would accrue AFTER the lender accelerated the loan.
Here’s how it would work:
Borrower misses 3 payments ==> Lender accelerates ==> from this point on, default rate applies
However, in Mr. Levy’s case, he did not accelerate the loan (possibly because he had no grounds to do so) and it matured after a year. The JCC did not pay it off. The parties had been negotiation for a long time, and finally, Mr. Levy recorded a Notice of Default since it had been a year since the loan matured (entitling him to 2 years of interest!).
Here’s where things went wrong for the lender:
• Lender asked for $455k of interest (2 years of interest at 5% is only $270k);
• Lender asked for $15k of attorney’s fees when only $4k was actually related to the foreclosure;
• Lender did not provide the borrower’s attorney with an explanation of the fees thereby violating California Civil Code § 2943, subd. (a)(5);
• Lender rejected borrower’s offer of the loan amount plus $270k of interest; and
• The borrower paid the full amount in protest and sued.
California Law Puts the Burden on the Lender to Expressly State When Default Interest Can Be Charged.
Mr. Levy’s note was boiler plate, possibly more than 10 years out of date, because a case had already come down a decade ago against the lender on the same issue. A lender cannot charge default interest if the loan has not been accelerated.
Levy tried to argue that the maturity was a missed payment and that the acceleration was AUTOMATIC. WRONG. The contract did not say that default interest could apply after maturity.
In contrast, the compounding provision was very clear, “Should interest not be paid when due, it shall thereafter bear like interest as principal, but such unpaid interest so compounded shall not exceed an amount equal to simple interest on the unpaid principal at the maximum rate permitted by law.” The Court agreed with Levy that the compounding provision was automatic so the borrower lost that challenge.
The JCC was awarded the attorney’s fees on appeal and the matter was remanded back to the trial court to recalculate the interest at the lower rate, and to credit the JCC for 21 days of interest since Levy did not respond to the JCC’s request for an explanation of the interest calculation. [JCC Development Corp. vs. Levy, 2012 Westlaw 3776544 (Cal.App.).]
Better Drafting Next Time
Lenders can learn some lessons from Mr. Levy’s case:
1. Tighten up the language of your promissory notes.
2. Know the basis for accelerating a loan.
3. Respond to the borrower’s request in a timely fashion.