• Sixth Circuit Affirms Judgment Against Borrower for Prepayment Penalty in Swap Agreement
  • January 20, 2012
  • Law Firm: Lerch Early Brewer Chartered - Bethesda Office
  • In a recent matter in Tennessee, a court determined that while a Loan Agreement and a Swap agreement may be construed as part s of the same transaction, each agreement provides for distinct and separate obligations.

    Many lenders now use Swap Agreements to provide fixed rate repayment alternatives to borrowers on variable rate loans. Under most loans utilizing swaps, while there may not be a prepayment fee charged under the note, the swap agreement normally provides for the possibility of termination fees in the event the loan is paid off and the swap is terminated. So long as the lender properly documents the loan transaction and swap transaction to provide for these fees, it should be able to enforce its rights to collect the early termination fees.

    On March 12, 2002, BKB Properties, LLC and SunTrust Bank entered into a commercial loan agreement and a derivative interest-rate swap agreement. SunTrust agreed to provide $6.96 million to finance BKB’s construction project for improvements on a property in Tennessee.

    The Loan Agreement provided that the term of the loan was for 20 years and that the loan could be paid in full, at any time, without penalty. BKB was to pay a variable interest rate on the loan. During negotiations, BKB expressed an interest in obtaining a fixed-rate loan, and SunTrust advised that this could be achieved through a Swap Agreement. Under a Swap Agreement, one party makes periodic interest payments to the other party at a fixed-rate on an agreed upon amount, often referred to as the notional amount, and the counter-party makes periodic interest payments at a variable rate on the same notional amount. The Swap Agreement provided BKB with a fixed rate of 8.08% of the notional amount for a 10 year term. Additionally, the Swap Agreement incorporated a termination fee in the event of early termination. Both the Loan Agreement and the Swap Agreements were secured by a deed of trust on the property.

    In 2004, BKB informed SunTrust that it wanted to refinance the loan. SunTrust informed BKB that it would be required to pay a substantial penalty in order to terminate the Swap Agreement. As a result, BKB did not refinance the loan.

    In March 2007, BKB informed SunTrust that it was going to prepay the Loan Agreement in full, and terminate the Swap Agreement. SunTrust refused to cancel the Swap Agreement or remove its lien from the property, unless BKB paid the swap termination fee. SunTrust stated that the Swap Agreement provided for unambiguous language that there would be a termination fee applied to BKB in the event of early termination.

    In April 2008, BKB filed suit against SunTrust for breach of contract and libel of title, in Tennessee state court. In May 2008, SunTrust removed the case to Tennessee federal district court, based upon diversity jurisdiction, and moved to dismiss BKB’s claims.

    The district court agreed with BKB’s contentions that the Loan Agreement and the Swap Agreement should be construed as parts of the same transaction. However, the district court held that each agreement provides for distinct and separate obligations. The Loan Agreement provides that BKB must repay the note, and the Swap Agreement provides for a separate obligation to make payments. Nowhere in the agreements does it provide that the Swap Agreement would be cancelled if the note was prepaid. Therefore, the obligations under the Swap Agreement remained.

    Additionally, the district court held that, even in the event that the note was paid in full, SunTrust had a right to retain its lien on the property until the Swap Agreement was fulfilled. Therefore, the district court held in favor of SunTrust, with regard to the libel of title claim.

    BKB appealed the decision to the Court of Appeals. The Court of Appeals affirmed the district court’s decision, stating that the Loan Agreement and the Swap Agreement created “two separate financial obligations.” One could be prepaid without penalty, and one could not. Additionally, the Court of Appeals stated that BKB was “a sophisticated commercial entity” that willingly entered into a contract with unambiguous terms.

    This case is cited as BKB Properties, LLC v. SunTrust Bank, 2011 WL 2711156 (C.A. 6 (Tenn.)).