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Judicial & Regulatory Alert
JUDICIAL ALERT
This memo was prepared
by Commericial Finance Association Co-General
Counsel Richard Kohn of Goldberg, Kohn Bell,
Black, Rosenbloom & Mortiz, Ltd. and Jonathan
N. Helfat of Otterbourg, Steindler, Houston
and Rosen, PC.
In a significant victory for
commercial lenders, New York State's highest
court has ruled that a lender may collect the
contractually agreed upon fee for early termination
of a revolving loan agreement following the borrower's
default. In JMD Holding Corp. v. Congress Financial
Corporation, 2005 WL 729150 (N.Y. Mar. 31, 2005),
the New York Court of Appeals addressed for the
first time the enforceability of liquidated damages
for early termination of a revolving loan agreement.
The
transaction was a fairly typical three year revolving
loan agreement with an early
termination fee calculated under a formula
of 2% of the maximum credit for early termination
in the first year, 1-1/2% in the second year
and 1% in the third year. Following the borrower's
breaches in the second year, the lender terminated
the agreement and collected the fee. The borrower
sued to recover the fee. The lower courts had
ruled that the nature of a revolving loan agreement
imposed no duty on the borrower to borrow;
therefore, the lower courts found it "speculative" whether
the borrower would ever borrow, and struck
down the early termination fee. After granting
the lender's motion for leave to appeal, the
New York Court of Appeals reversed, and held
that the essence of revolving credit, where
the balance of the loan can increase and decrease
over the course of the loan, made liquidated
damages (i.e., a fixed sum or formula calculation
of damages agreed at the time of contracting)
for early termination all the more appropriate,
because at the time the loan agreement was
entered into, there was no way to forecast
precisely how much would be borrowed or for
how long, so an exact calculation of damages
was difficult, the very scenario generally
giving rise to enforcement of liquidated damages.
The
Court of Appeals held that, at the time of
the execution of the loan agreement, the
parties could not readily predict the amount
of borrowing for which JMD would qualify under
the asset-based formula, which would fluctuate
over its term; how much JMD would actually
borrow; whether the agreement would be terminated
early; and how much JMD would have borrowed
if the agreement had not been terminated early.
The Court also found that that Congress was
required to limit its lending activities to
ensure that adequate funds were available to
fulfill its $40 million obligation to JMD,
and that Congress would incur costs to procure
substitute borrowers in the event that JMD
breached the agreement, causing Congress to
terminate it. The Court further noted that
in this agreement, the early termination fee
was based upon a percentage of the maximum
credit, with the percentage decreasing as the
agreement's term approached.
The CFA filed an
amicus curiae brief in support of Congress'
position, and the Court quoted
the CFA's brief for the proposition that "an
early termination fee, structured as liquidated
damages based on a sliding scale and linked
to the amount of the commitment…, is
a common feature in asset-based lending facilities
negotiated by sophisticated commercial parties."
The
Court observed that the termination of the
agreement came about following defaults
by the borrower and acceleration by the lender,
so it therefore should make no difference whether
the borrower terminated voluntarily or the
lender terminated after breach, so long as
the breach was material.
This decision should
give comfort to revolving loan lenders who
have sliding scale early termination
fees in their agreements that are governed
by New York law.
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2008 - Commercial Finance Association - All Rights Reserved
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