WOLIN, UNITED STATES DISTRICT JUDGE
This is a case involving a promissory note and a mortgage on commercial property. Plaintiff, the property owner, claims that defendant, the note holder and mortgagee, improperly refused its consent to plaintiff's sale of the property and that plaintiff suffered adverse tax consequences and other damages as a result thereof. Plaintiff seeks damages and relief under the Declaratory Judgment Act, 28 U.S.C. §§ 2201-2202. Jurisdiction is based on diversity of citizenship.
The parties have filed cross-motions for summary judgment. The Court will grant defendant's motion.
The material facts in the case are not in dispute. Plaintiff Warrington 611 Associates ("Warrington") is a Pennsylvania limited partnership that owns a shopping center located at the corner of Routes 123 and 611 in Warrington, Pennsylvania. The general partners and principals of Warrington are Roger Whyman, a lawyer, and Joseph Flotteron, an architect and engineer. Aetna Life Insurance Co. ("Aetna") is the holder of a promissory note and a mortgage on the shopping center property.
On approximately March 8, 1976, Warrington applied to Aetna, on a standard Aetna form, for a mortgage loan in the amount of $ 2,400,000 to finance the shopping center project. The first page of the mortgage loan application contained a provision prohibiting prepayment of the loan within the first 11 years (i.e., until 1988) and allowing prepayment thereafter only if Warrington paid a prepayment charge of 5% for prepayment in the twelfth year; this fee would be gradually reduced by 1% per year to a minimum charge of 1% for prepayment in subsequent years.
Aetna issued a permanent loan commitment on March 19, 1976, as amended on March 26, 1976. Warrington accepted the commitment as amended on April 5, 1976.
On or about June 18, 1976, Warrington executed a note to the Philadelphia National Bank, the construction lender on the Warrington project, in the principal sum of $ 2,400,000 plus interest at the annual rate of 9.75%. On that same date, Warrington, as mortgagor, executed a mortgage to the Philadelphia National Bank securing the note. Pursuant to a permanent loan buy/sell agreement between the Philadelphia National Bank and Aetna, and by an assignment executed on October 18, 1977, Aetna acquired and now holds the Note and is the current mortgagee on the Mortgage.
Paragraph 8 of the Note provides for the same prepayment restrictions specified in the mortgage loan application.
Paragraph 20 of the Mortgage, which the parties agree is a "due-on-sale" clause, prohibits Warrington, under penalty of default, from transferring title to the mortgaged property without the prior written consent of Aetna.
It is these two provisions of which Warrington complains.
In September of 1986, Whyman began negotiating with Realco, Inc., a New York corporation, over the sale of the shopping center property to Realco.
According to Whyman, he and Realco "firmed up [their] negotiations" for the sale of the Warrington property on December 14, 1986.
On December 17, 1986, Whyman telephoned Aetna to advise it that Warrington had reached an agreement to sell the mortgaged property and that the closing was to take place before December 31, 1986. According to Whyman, he requested that Aetna send him a "pay-off" letter so that he could sell the property.
Whyman avers that the Aetna representative with whom he spoke
told him that she would send the pay-off letter out by overnight mail.
Aetna did not send any such letter.
Shortly after his conversation with the Aetna employee, Whyman telephoned Lattimer & Buck, Aetna's correspondent agent on the Warrington loan, and spoke with Martin Woodrow, the Lattimer & Buck employee responsible for the loan. In that conversation, Woodrow informed Whyman that it was Aetna's practice to require a fee as a condition of prepayment in cases in which prepayment was prohibited by the loan documents. Woodrow further informed Whyman that Warrington was "locked in" to the loan and would thus have to pay such a prepayment fee in order to be able to sell the mortgaged premises. Whyman responded with his view that such a fee only applied to a refinancing of the loan (when the mortgagor continued to hold the property) but was inapplicable and inappropriate in the case of a sale of the property.
On December 22, 1986, Flotteron telephoned Woodrow to further discuss a prepayment of the loan.
According to Whyman, Woodrow informed Flotteron that "any requests that were going to be made to Aetna from us had to be in writing hereafter and had to go through [Woodrow]."
Warrington never submitted a request in writing to Aetna through Woodrow or otherwise.
On December 23, 1986, the day after Flotteron's conversation with Woodrow, Whyman wrote a letter to Aetna memorializing his conversation with Woodrow and setting forth his opinion on the matter. The letter stated in part:
I told Mr. Woodrow of, and asked him as your agent to convey to you, our position that it was illegal and improper for you to demand both a pre-payment penalty and a due-on-sale clause and that your position prevented and restrained our ability to sell our project. I also advised your agent that your prepayment clause was only intended to apply to us as borrower if we wanted to prepay the mortgage but remain as the owner of the project. However, you and your agent are attempting to apply the pre-payment penalty as a condition of your allowing us to sell our project and satisfy the lien of your mortgage on the sale.
The letter was received by Woodrow at Lattimer & Buck on December 24, 1986, but not by Aetna until January 6, 1987.
On December 30, 1986, representatives of Warrington and Realco met in New York City for a "pre-closing." The meeting continued into late evening. It is undisputed that a contract of sale was never executed. Warrington contends, however, that an agreement was reached for the sale of the premises. Aetna disputes this.
The property was not sold to Realco by the end of 1986 and has not been sold by Warrington since then. Because of the change in the federal tax laws as of the beginning of 1987, Warrington alleges that it sustained financial losses by its inability to sell the property to Realco by the end of 1986.
During the period in question, it was Aetna's policy to allow prepayment of notes even when the notes by their terms prohibited prepayment. As a condition of its consent, however, Aetna would require the borrower to compensate or "immunize" Aetna for the economic loss that it would sustain as a result of the prepayment. This compensation would be in the form of a "yield maintenance fee." An analyst at Aetna would compute this fee by determining the total prepayment amount that, when invested at the prevailing market rate, would yield a return equivalent to the return that Aetna would receive if the loan ran the full term.
Aetna had procedures for processing prepayment requests. The first step in the procedure was for the borrower to submit in writing its request for prepayment, along with a $ 500 processing fee. Aetna would also require certain information about the property, such as operating statements and a current rent roll. In addition, for prepayment in the context of a sale of the property, Aetna would require the borrower to submit an executed sales contract.
Warrington never complied with these procedures, apparently because of Whyman's view that a prepayment fee was inappropriate in the context of a sale. Even if Warrington had complied with the procedures, it probably would not have been able to obtain a pay-off letter from Aetna in time because Aetna had developed a policy in late November or early December that all requests for prepayment by the end of 1986 would have to be received by Aetna by December 15, 1986. Aetna developed this policy because of a deluge of such requests that it was receiving by borrowers who wanted to sell their property before the imminent change in the federal tax laws.
I. Does a Prepayment Prohibition Unreasonably Restrain Alienation of Property ?
Warrington alleges that the prepayment restriction in the loan documents is an impermissible restraint on alienation. Aetna contends, and Warrington does not dispute, that Pennsylvania law governs the transaction in question.
Under Pennsylvania law, the Court finds such prepayment restrictions to be valid in the commercial context.
The starting point in the analysis is to determine whether the prepayment restriction is a restraint on alienation at all. According to the Restatement, a condition imposing contractual liability on one who later conveys property in violation of the agreement is a "promissory" restraint on alienation. Restatement of Property § 404(1)(b) & (2) (1944). The Court agrees that the prepayment restriction in para. 8 of the Note is such a restraint. The next step in the inquiry is to determine whether this restraint is reasonable or unreasonable.
Initially, the question might be asked how a prepayment fee could possibly be reasonable: if the lender can collect the balance of the loan's principal sum and all interest due to date, and can presumably reinvest the funds elsewhere, then doesn't that give it the benefit of its bargain? The short answer is that receipt of the principal balance and accrued interest does not give the lender the benefit of its bargain. In contracting to lend its money, the lender has bargained for a particular rate of return over a specified period of years. If interest rates have declined since the loan transaction, then the lender will suffer a loss in reinvesting the funds at the currently lower rate for the duration of the original loan term. As one court has noted, "there is an expense attached to loaning money on real property, and it is an entirely legitimate aim of purveyors of credit to loan it for a length of time and at a rate of interest which guarantees a certain net return on the management of money." Hartford Life Insurance Co. v. Randall, 283 Or. 297, 583 P.2d 1126, 1127 (1978); see also La Sala v. American Savings & Loan Ass'n, 5 Cal. 3d 864, , 97 Cal. Rptr. 849, 489 P.2d 1113 n.l7, La Sala v. American Savings & Loan Ass'n, 5 Cal. 3d 864, 489 P.2d 1113, 1123 n.17, 97 Cal. Rptr. 849, 859 n.17 (1971). Beyond the loss of the bargained-for rate of return, prepayment can cause serious economic consequences, such as an increased tax burden and unexpected reinvestment costs; for those investors whose purpose in lending money was to ensure a stable annual income for a period of years, it can also cause a frustration of that purpose. Arthur v. Burkich, 131 A.D.2d 105, 520 N.Y.S.2d 638, 639 (1987) (citing Alexander, Mortgage Prepayment: The Trial of Common Sense, 72 Cornell L. Rev. 288, 310-17 (1987)). A "yield maintenance fee" is the sum that, when invested at prevailing interest rates along with the unpaid balance of the loan and the accrued interest, will provide the lender -- for the duration of the original term of the loan -- with the rate of return for which it bargained. Although it may not solve all the problems that may be caused by prepayment, a yield maintenance fee at least relieves the lender of the loss of its expected rate of return for the duration of the loan term.
In Mahoney v. Furches, 503 Pa. 60, 468 A.2d 458 (Pa. 1983), the Supreme Court of Pennsylvania addressed the validity of prepayment restrictions in light of the general common law policy against restraints on alienation. Even in commercial transactions, the Mahoney court held, a right to prepayment would be presumed where the mortgage was silent as to the existence of such a right. Id. at 65, 468 A.2d at 461.
This presumption, however,
could be rebutted by showing a contrary intent mutually manifested by the parties. Such a presumption would not work a hardship on the mortgagee since, in virtually all instances, he is the drafter of the mortgage note and can thus include within the note a clause stating that the note is not subject to prepayment. This would put the mortgagor on notice that he will in all probability be restrained from selling the land for the duration of the term. If he signs the note containing such a provision, he will then be bound by it even though it may restrain his right to its sale or use.
Id. at 65-66, 468 A.2d at 461. In dicta, the Mahoney court went on to temper its holding by stating that
consistent with the policy against restraints on alienation, even where the mortgage explicitly states there is no right to prepay the note, if the mortgagor can provide the mortgagee with the benefit of his bargain under the terms of the note, he will be allowed to have a release of his land following the substitution of security or other arrangement.