Source: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-azd-2_09-cv-00006/USCOURTS-azd-2_09-cv-00006-0/pdf.json

Nature of Suit Code: 190
Nature of Suit: Other Contract Actions
Cause of Action: 28:1332 Diversity-Declaratory Judgment

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IN THE UNITED STATES DISTRICT COURT 

FOR THE DISTRICT OF ARIZONA

UIP Limited, L.L.C., an Arizona limited

liability company, 

Plaintiff/Counterdefendant,

vs.

Lincoln National Life Insurance Company,

an Indiana corporation, 

Defendant/Counterclaimant.

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No. CV09-0006-PHX-NVW

FINDINGS OF FACT, 

CONCLUSIONS OF LAW, 

and

ORDER

Plaintiff UIP Limited, L.L.C. (“UIP”) and Defendant Lincoln National Life

Insurance Company (“Lincoln”), as successor-in-interest to Jefferson-Pilot Life Insurance

Company (“Jefferson-Pilot”), seek a declaratory judgment as to the interpretation of a

prepayment premium provision in a non-recourse promissory note signed by UIP in

exchange for a loan from Jefferson-Pilot. The parties originally submitted cross-motions

for summary judgment (doc. ## 52, 60). However, the parties have stipulated to a bench

trial in accordance with the waiver of jury trial in the promissory note and on the evidence

now before the Court. Therefore, the motions will be treated as trial briefs, and the Court

has heard the arguments of counsel. This order states the Court’s findings of fact and

conclusions of law in accordance with Fed. R. Civ. P. 52(a). 

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I. Facts

The following facts are entirely or almost entirely undisputed, but to the extent the

facts may be subject to any reasonable dispute, this constitutes the Court’s findings of

fact. On or around September 13, 1999, Dale and Dawn Zeitlin signed a Purchase and

Sale Agreement for the purchase of commercial real estate in Tempe, Arizona. In order

to finance the purchase, the Zeitlins obtained loan quotes from two lenders, JeffersonPilot and Minnesota Mutual Life Insurance. Both quotes included a prepayment penalty

equal to “yield maintenance.” On September 21, 1999, and again on September 27, 1999,

Dale Zeitlin applied for a loan from Jefferson-Pilot on behalf of Zeitlin Limited, L.L.C.

(“Zeitlin Limited”). The Mortgage Loan Application specified that prepayment options

would be “[c]losed for 7 years; standard yield maintenance thereafter; open last 90 days.” 

At that time, Mr. Zeitlin understood “yield maintenance” to mean that in the event of

prepayment of the loan, Jefferson-Pilot would still get the contract rate of return on the

loan. 

On October 15, 1999, Jefferson-Pilot signed a Loan Approval, approving a loan to

Zeitlin Limited in the amount of $2,900,000, prepayment of which would be closed for

seven years, “open to prepayment thereafter at the greater of 1% of the principal loan

balance or yield maintenance,” and open for the last 90 days of the loan term. On

October 25, 1999, both Dale and Dawn signed a Mortgage Loan Commitment,

committing Zeitlin Limited to the loan subject to several changes and clarifications, none

of which pertained to prepayment of the loan. Exhibit C of the Mortgage Loan

Commitment delineates the “Prepayment Privilege,” which would require Zeitlin Limited

to pay a prepayment premium that, together with the amount prepaid, would be

“sufficient to invest in a U.S. Treasury obligation for the remaining term of the Loan to

produce the same effective yield to maturity as the Loan.” The provision further specifies

that the prepayment premium will be the greater of:

(1) one percent (1%) of the then outstanding principal balance of the Loan,

or

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(2) the sum of the present value of the scheduled monthly payments on the

Loan from the date of prepayment to the maturity date minus the

outstanding principal Loan Balance as of the date of prepayment. The

present value will be computed on a Monthly basis as of the date of

prepayment, discounted at the “Treasury Yield”. . . .

Neither Dale nor Dawn Zeitlin objected to the prepayment premium provision at the time

they signed the Mortgage Loan Commitment.

On November 18, 1999, Zeitlin Limited changed its name to UIP Limited, L.L.C.

(“UIP”). On December 8, 1999, Dawn Zeitlin, on behalf of UIP, signed a promissory

note (“Note”) drafted by Jefferson-Pilot. The Note specifies that UIP will repay to

Jefferson-Pilot a loan in the amount of $2,800,000 plus interest at a contract rate of 8.1%

per annum. The loan is to be repaid over fifteen years based on a twenty-five year

amortization schedule. Provision 1 of the Note states that Plaintiff is obligated to repay

the principal and interest as follows:

(a) Commencing on the first day of February, 2000 (the “First Payment Date”)

and on the first day of each month thereafter until this Note matures, principal

and interest in consecutive equal installments of . . . $21,797.00 (the initial

payment and each subsequent payment shall each hereinafter be referred to as

“Monthly Payment”); and

(b) On January 1, 2015 (the “Maturity Date”), the entire unpaid principal

amount, together with accrued and unpaid interest thereon, and all other sums

due under this Note or under any other documents evidencing or securing this

Note (collectively, the “Loan Documents”), shall be due and payable in full.

. . . interest due on the First Payment Date shall be calculated on the

basis of the actual number of days elapsed between the Disbursement Date and

the First Payment Date. If the interest due and accrued on the First Payment

Date is more or less than one month, the Monthly Payment due on the First

Payment Date shall be increased or decreased to the extent that the amount of

interest then due exceeds or is less than one month’s interest. 

 Finally, the “Prepayment” provision, found in Exhibit B to the Note, states that UIP is

prohibited from prepaying the Note for seven years from the date of the Note. Thereafter,

UIP may prepay the Note in full so long as it pays a prepayment premium and gives

Jefferson-Pilot notice of a prepayment date. The prepayment premium is calculated as

follows: 

The Prepayment Premium shall be the greater of (a) one percent (1%) of the

outstanding principal balance of the Note on the Prepayment Date, or (b) the

remainder of (i) the sum of the present values (determined using periodic

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monthly intervals and a discount rate equal to the Treasury Yield) of the then

remaining unpaid Monthly Payments due under this Note to the Maturity Date

minus (ii) the outstanding principal balance of this Note as of the Prepayment

Date. The “Treasury Yield” is the yield in percent per annum of the Treasury

Constant Maturities for the length of time from the Prepayment Date to the

Maturity Date . . . .

The prepayment premium is therefore equal to the greater of the 1% amount under

subsection (a) or the amount derived from the formula under subsection (b).

On November 26, 2008, Dale Zeitlin sent written notice to Jefferson-Pilot of UIP’s

election to prepay the outstanding balance of the loan, together with interest, “assuming

that the prepayment premium is in the amount of 1% of the outstanding principal balance

on January 1, 2009.” Zeitlin stated that it was UIP’s understanding that the “principal

balance at that time will be in the approximate amount of $2,347,608.69, which means

that the prepayment premium is $23,476.09.” UIP’s understanding was based on a

subsection (b) calculation that did not include the final balloon payment of $1,810,394.78

as of a January 1, 2009 pay-off date. The subsection (b) formula therefore produced a

negative number. On December 3, 2008, Jefferson-Pilot responded that UIP’s

understanding was incorrect, and that the amount under subsection (b) was higher than

the amount under subsection (a). Jefferson-Pilot’s calculation under subsection (b)

included the final balloon payment of $1,810,394.78 within the definition of “Monthly

Payments.” That calculation produced a prepayment premium of $678,000 as of a

January 1, 2009 pay-off date. 

The following additional facts pertaining to the operation of the prepayment

provision are also undisputed. First, a calculation of the prepayment premium under

subsection (b) involves a Treasury Yield discount rate, also known as a Constant Maturity

Treasury rate (“CMT”). CMTs are reported by the Federal Reserve Statistical Release. 

As of a pay-off date of January 1, 2009, if the final balloon payment is not included in the

calculation under subsection (b)(i), the premium is negative for all positive CMTs and all

negative CMTs from 0% to -3%. Exclusion of the balloon payment therefore means that

the premium in subsection (b) will only be greater than the 1% premium in subsection (a)

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when the CMT is lower than -3%. Since the Federal Reserve Statistical Release began to

report CMTs in 1962, CMTs have never been reported as negative. On the other hand, if

the balloon payment is included in the calculation, the 1% premium in subsection (a) is

higher when the CMT is above or very close to the contract rate of 8.1%. When the CMT

is below the contract rate, for example 5%, the premium in subsection (b) is higher than

the 1% premium in subsection (a). 

Second, if the balloon payment is included in the calculation of the premium under

subsection (b) and the prepaid amount, together with the premium under subsection (b), is

reinvested at a commercial loan market rate very close to the contract rate of 8.1% for the

remaining term of the loan, Lincoln will earn more than it would have earned on the

contract had the loan not been prepaid. On the other hand, if the balloon payment is

included in the calculation and the prepaid amount, together with the premium under

subsection (b), is reinvested in a treasury obligation for the remaining term of the loan at

the same rate used to calculate the premium, Lincoln will earn almost exactly what it

would have earned on the contract had the loan not been prepaid.

Finally, if the balloon payment is excluded from the calculation under subsection

(b) and the prepaid amount, together with 1% premium under subsection (a), is reinvested

at a commercial loan market rate very close to the contract rate of 8.1% for the remaining

term of the loan, Lincoln will earn close to what it would have earned on the contract had

the loan not been prepaid. On the other hand, if the balloon payment is excluded from the

calculation under subsection (b) and the prepaid amount, together with the 1% premium

under subsection (a), is reinvested in a treasury obligation for the remaining term of the

loan at the same rate used to calculate the premium, Lincoln will earn roughly $757,000

less than what it would have earned on the contract had the loan not been prepaid.

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II. Analysis

The parties dispute the interpretation of subsection (b) of the prepayment premium

formula, which ultimately boils down to a dispute over the meaning of the term “Monthly

Payment” in the Note. Lincoln, relying on evidence of the parties’ intent and prior

negotiations, argues that the term includes the final balloon payment. UIP, relying solely

on the language of the Note, maintains that the term “Monthly Payment” does not include

the final balloon payment due on the maturity date. Alternatively, UIP argues that if

Lincoln’s interpretation is correct, the prepayment premium is an unenforceable penalty

and is unconscionable.

A. Interpretation of the Note’s Prepayment Provision

Provision 20 of the Note specifies that the Note is “governed by and construed in

accordance with the laws of the state in which the property is located . . . .” Because the

subject property is located in Arizona, the Note is governed by and construed in

accordance with Arizona law. When construing an agreement under Arizona law, a court

must give effect to the intent of the parties at the time the agreement was made. Taylor v.

State Farm Mut. Auto. Ins. Co., 175 Ariz. 148, 153, 854 P.2d 1134, 1139 (1993); Sam

Levitz Furniture Co. v. Safeway Stores, Inc., 105 Ariz. 329, 331, 464 P.2d 612, 614

(1970). Before Taylor, courts looked only to the plain meaning of the words “as viewed

in the context of the contract as a whole” in order to ascertain the parties’ intent. United

Cal. Bank v. Prudential Ins. Co. of Am., 140 Ariz. 238, 259, 681 P.2d 390, 411 (Ct. App.

1983). If the meaning of the disputed language could be determined from the four

corners of the contract and could not “reasonably be construed in more than one sense,”

extrinsic evidence was irrelevant and inadmissible. Id. at 258, 681 P.2d at 410. In other

words, an ambiguity in the meaning of the contract language had to exist before extrinsic

evidence was even considered. 

In Taylor, however, the Arizona Supreme Court decided that ambiguity in the

contract language is not necessary to consider extrinsic evidence of the parties’ intent for

purposes of interpreting the contract language. 175 Ariz. at 154, 854 P.2d at 1140. 

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Rather, in accordance with the Corbin view of contract interpretation, a court must now

“first consider[] the offered evidence and, if [it] finds that the contract language is

‘reasonably susceptible’ to the interpretation asserted by its proponent, the evidence is

admissible to determine the meaning intended by the parties.” Id. at 154, 854 P.2d at

1140. This approach recognizes that a term that appears to be plain and unambiguous on

its face is not so plain and unambiguous in light of extrinsic evidence of the parties’

intent. Id. It is based on the principle that although extrinsic evidence is not admissible

to vary or contradict the terms of a contract, it is admissible to interpret a contract. Id. at

152, 854 P.2d at 1138.

Taylor therefore requires courts to engage in a two-step process when interpreting

disputed contract language. First, the court decides whether the contract language is

reasonably susceptible to more than one meaning in light of all evidence of the parties’

prior negotiations, understandings, and other extrinsic evidence of the parties’ intent. Id.

at 153, 154, 854 P.2d at 1139, 1140; see also Long v. City of Glendale, 208 Ariz. 319,

328, 93 P.3d 519, 528 (Ct. App. 2004). Whether the language is reasonably susceptible

to multiple interpretations is a question of law. Taylor, 175 Ariz. at 158-59, 854 P.2d at

1144-45. A court must “apply a standard of reasonableness” to contract language and

must construe the contract “in its entirety and in such a way that every part is given

effect.” State ex rel. Goddard v. R.J. Reynolds Tobacco Co., 206 Ariz. 117, 120, 75 P.3d

1075, 1078 (Ct. App. 2003). Therefore, the contract should be interpreted, if possible, “in

a way that does not render parts of it superfluous.” Taylor, 175 Ariz. at 158 n.9, 854 P.2d

at 1144 n.9. 

In the second step, the court decides whether to admit the extrinsic evidence based

on its determination of whether the contract is reasonably susceptible to the proponent’s

interpretation. Id. at 154, 854 P.2d at 1140; Long, 208 Ariz. at 328, 93 P.3d at 528. If

the language is reasonably susceptible to that interpretation, the court should admit the

extrinsic evidence to ascertain the parties’ intended meaning. Id. On the other hand, if

the court finds that the language is not reasonably susceptible to that interpretation, it

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must exclude any extrinsic evidence that varies or contradicts the meaning of the contract

language as written. Id. 

1. Extrinsic Evidence of the Parties’ Intent

Evidence of the parties’ prior negotiations, understandings, and other extrinsic

evidence indicates that Jefferson-Pilot intended to provide for a prepayment premium

based on standard yield maintenance, and that UIP was well aware of that intent. The

loan quote from Jefferson-Pilot states that the prepayment premium would be equal to

“yield maintenance.” The Mortgage Loan Application specifies that prepayment options

would be “[c]losed for 7 years; standard yield maintenance thereafter; open last 90 days.” 

The Loan Approval indicates that the prepayment premium would be “the greater of 1%

of the principal loan balance or yield maintenance.” 

Yield maintenance prepayment provisions are “nothing new.” River E. Plaza,

L.L.C. v. Variable Annuity Life Ins. Co., 498 F.3d 718, 721 (7th Cir. 2007) (citing Dale A.

Whitman, Mortgage Prepayment Clauses: A Legal and Economic Analysis, 40 UCLA L.

REV. 851, 871 (1993)). Their purpose is to compensate the lender for any loss on return

when the borrower opts to prepay the loan during a time when the market rate is lower

than the contract rate of return. Id.; Whitman, supra, at 860. The intended goal of a yield

maintenance formula is to produce a prepayment premium, which, together with the

amount prepaid, allows the lender to earn the same yield on reinvestment as it would have

if the borrower had not prepaid and had made all scheduled payments over the life of the

loan. 

Throughout the loan negotiations, UIP understood “yield maintenance” to mean

that in the event of prepayment of the loan, Jefferson-Pilot would still get the contract rate

of return on the loan. UIP maintains that there was no mutual understanding as to what

vehicle or interest rate would be used for reinvestment of the prepaid amount and the

premium, but the Mortgage Loan Commitment very clearly states that the prepayment

premium, together with the amount prepaid, must be “sufficient to invest in a U.S.

Treasury obligation for the remaining term of the Loan to produce the same effective

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yield to maturity as the Loan.” There is nothing to suggest that UIP did not have ample

opportunity to review the Mortgage Loan Commitment before signing it. Therefore, the

parties contemplated a prepayment premium which, together with the amount prepaid,

would be sufficient to earn the same amount upon reinvestment in a treasury obligation

for the remaining term of the loan as it would have earned if the loan had not been

prepaid. It is in light of this evidence that the Court must decide whether the prepayment

premium formula in the Note is reasonably susceptible to Lincoln’s interpretation. 

2. The Language of the Prepayment Premium Formula

The prepayment premium formula, outlined in Exhibit B to the Note, states:

The Prepayment Premium shall be the greater of (a) one percent (1%) of the

outstanding principal balance of the Note on the Prepayment Date, or (b)

the remainder of (i) the sum of the present values (determined using

periodic monthly intervals and a discount rate equal to the Treasury Yield)

of the then remaining unpaid Monthly Payments due under this Note to the

Maturity Date minus (ii) the outstanding principal balance of this Note as of

the Prepayment Date . . . .

The language of subsection (b) therefore requires a person calculating the prepayment

premium to subtract the outstanding principal balance, as of some designated prepayment

date, from the sum of the present values of the “unpaid Monthly Payments due under this

Note to the Maturity Date.” 

The terms “Monthly Payments” and “Maturity Date” are defined in provision 1 of

the Note, which states that the principal and interest are payable as follows: 

(a) Commencing on the first day of February, 2000 (the “First Payment Date”)

and on the first day of each month thereafter until this Note matures, principal

and interest in consecutive equal installments of . . . $21,797.00 (the initial

payment and each subsequent payment shall each hereinafter be referred to as

“Monthly Payment”); and

(b) On January 1, 2015 (the “Maturity Date”), the entire unpaid principal

amount, together with accrued and unpaid interest thereon, and all other sums

due under this Note or under any other documents evidencing or securing this

Note (collectively, the “Loan Documents”), shall be due and payable in full.

It is undisputed that the “Maturity Date” is January 1, 2015, and that in the event the loan

is not prepaid, provision 1(b) requires UIP to make a final balloon payment of the

outstanding principal, plus interest, on that date. 

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The dispute centers on the term “Monthly Payment.” If subsection (b) operates as

the parties contemplated, the premium under subsection (b) should be higher than the 1%

premium under subsection (a) whenever the CMT is below the contract rate. This would

compensate Jefferson-Pilot for the loss on the contract discounted by what Jefferson-Pilot

could earn if it reinvested the prepaid loan and premium in a treasury obligation at the

lower CMT rate. For subsection (b) to achieve that desired result, the final balloon

payment must be included in the present value calculation, because if it is not, the 1%

premium in subsection (a) is always higher for all positive CMTs and all negative CMTs

from 0% to -3%. Therefore, the dispute boils down to whether the term “Monthly

Payment” is reasonably susceptible to an interpretation that would include the final

balloon payment. 

“Monthly Payment” is defined as “the initial payment and each subsequent

payment . . . .” It is undisputed that “initial payment” refers to the first payment to be

made on February 1, 2000, the “First Payment Date.” Lincoln argues, however, that

“each subsequent payment” can reasonably be interpreted to include the final balloon

payment, because the final payment is literally a subsequent payment, albeit not one of

the equal installments of $21,797. This argument is persuasive considering only the

definition of “Monthly Payment,” because the balloon payment is literally a payment to

be made subsequent to the initial payment, and it too is due on the first day of the month

(January 1, 2015). 

However, the inquiry cannot end there. The interpretation must be reasonable, not

merely possible or plausible. A determination of reasonableness requires the term to be

considered within the context of the Note as a whole, because the Note must be construed

in its entirety and in a way that gives effect to all parts. The language immediately

surrounding the definition of “Monthly Payment” suggests that the term does not include

the final balloon payment. The definition is included within a provision that deals

exclusively with consecutive equal installments of $21,797 that are due on the first day of

each month. The fact that the definition of “Monthly Payment” immediately follows the

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description of the equal installments strongly suggests that the term was intended to

describe only the equal installments of $21,797 each. The final balloon payment is

plainly not one of the equal installments. 

Lincoln argues, however, that the language directly below provision 1(b) indicates

that “Monthly Payment” cannot be interpreted to mean only equal installments. That

language states: 

. . . interest due on the First Payment Date shall be calculated on the

basis of the actual number of days elapsed between the Disbursement Date and

the First Payment Date. If the interest due and accrued on the First Payment

Date is more or less than one month, the Monthly Payment due on the First

Payment Date shall be increased or decreased to the extent that the amount of

interest then due exceeds or is less than one month’s interest. 

According to the above language, the first payment may be slightly higher or slightly

lower than $21,797, depending on whether more or less than one full month elapses

between the disbursement date and the first payment date. Lincoln maintains that because

the initial payment may be slightly higher or lower than the subsequent installments of

$21, 797, the term “Monthly Payment,” which includes “the initial payment,” cannot refer

only to equal installments of $21,797. This argument, while correct in a technical sense,

is not without its flaws, because it provides no answer to the fact that the definition of

“Monthly Payment” appears in a provision that deals exclusively with equal monthly

installments of $21,797. In addition to that problem, the final balloon payment is

described in an entirely separate provision from the one that includes the definition of

“Monthly Payment.” While “Monthly Payment” is defined in provision 1(a), the final

balloon payment is described in provision 1(b), suggesting that these two amounts were

intended to be mutually exclusive. 

Lincoln relies on Fishman v. LaSalle Nat’l Bank, 247 F.3d 300 (1st Cir. 2001), to

support its position. Like this case, Fishman involved a dispute over the correct

interpretation of a prepayment premium provision in a promissory note. Id. at 301. In

pertinent part, the provision stated: 

“Prepayment Premium” . . . shall be the greater of (a) one percent (1%) of the

outstanding principal balance of the Note, or (b) a Yield Maintenance

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Prepayment Premium . . . equal to the product of (i) the outstanding principal

balance due hereunder (including accrued interest) at the time of prepayment

multiplied by (ii) the “Monthly Interest Differential” (as hereinafter defined),

and (iii) discounted by the “Treasury Yield” . . . rate over the number of

months then remaining to the end of the fifth Loan Year.

Id. The borrower read the formula to require a single calculation involving the

outstanding balance, while the lender read the formula to require a series of month-tomonth calculations determining the present value of what the lender would lose in the

event of prepayment. Id. at 302. The district court ruled in favor of the lender, relying on

a commitment letter that illustrated the operation of the formula using a series of monthly

calculations rather than a single calculation. Id. The district court also based its

conclusion on the fact that the borrower’s interpretation would render some terms

superfluous. Id. The First Circuit affirmed, noting that “the meaning of the prepayment

terms taken as a whole is not ambiguous once the calculations themselves are fully

understood.” Id. The court emphasized that the lender’s interpretation made sense

because it “carrie[d] out what one might imagine to be a plausible objective of parties so

situated . . . .” Id. 

In Fishman, the court interpreted the prepayment premium formula in a way that

gave effect to the lender’s intent to provide for yield maintenance. Evidence of the

parties’ intent supported the lender’s interpretation, because the commitment letter

included a precise example of how the formula worked, which likely dispelled most if not

all of the ambiguity in the provision. The lender’s interpretation was also reasonable in

light of the language of the prepayment provision as a whole, because it did not require

the court to expand the meaning of a defined term. The ambiguity was inherent in the

meaning of a few undefined words. 

In this case, the textual evidence of the parties’ intent from the Note alone is not as

clear. The evidence shows that the parties contemplated a yield maintenance provision,

but the Note alone does not speak to the parties’ specific understanding of whether the

calculation of yield maintenance would include the final balloon payment. Furthermore,

the language of the prepayment provision in this case is not as open to Lincoln’s

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interpretation as the Fishman provision was open to the lender’s interpretation in that

case. On the one hand, the definition of “Monthly Payment” in the Note is literally and

technically amenable to an interpretation that would include the final balloon payment. 

On the other hand, the context in which the definition appears suggests that “Monthly

Payment” does not include the final balloon payment. 

In such a close case, as the Fishman court recognized, “[c]ommon sense is as

much a part of contract interpretation as is the dictionary or the arsenal of canons.” 

Fishman, 247 F.3d at 302. Moreover, “[t]he presumption in commercial contracts is that

the parties were trying to accomplish something rational.” Id. In this case, if the balloon

payment is not included in the calculation of the prepayment premium formula under

subsection (b), the formula utterly fails to achieve the rational goal of yield maintenance. 

UIP argues that an exclusion of the balloon payment still enables Lincoln to achieve yield

maintenance, because if the prepaid amount, together with 1% premium under subsection

(a), is reinvested in a commercial loan at a market rate very close to the contract rate of

8.1% for the remaining term of the loan, Lincoln will earn close to, if not more than, what

it would have earned on the contract had the loan not been prepaid. This argument relies

on the assumption that the prepaid amount and the premium would be reinvested in a

commercial loan bearing an interest rate similar to the contract rate of 8.1%. This

assumption, and therefore the argument, is meritless because the Mortgage Loan

Commitment clearly indicates that Lincoln intended for the premium, together with the

prepaid amount, to be sufficient to earn the same yield if reinvested in a treasury

obligation at the treasury rate used to calculate the premium. 

As noted, if the balloon payment is excluded from the calculation under subsection

(b) and the prepaid amount, together with the 1% premium under subsection (a), is

reinvested in a treasury obligation for the remaining term of the loan at the same rate used

to calculate the premium, Lincoln will earn roughly $757,000 less than what it would

have earned on the contract. Such a result clearly fails to achieve the mutually-intended

goal of allowing Lincoln to maintain its bargained-for yield on the contract. If, on the

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other hand, the balloon payment is included in the calculation and the prepaid amount,

together with the premium under subsection (b), is reinvested in a treasury obligation for

the remaining term of the loan, as was contemplated by the parties in the Mortgage Loan

Commitment, Lincoln will earn almost exactly what it would have earned on the contract. 

Common sense and the goal of giving effect to the parties’ intent therefore require

the final balloon payment to be included in the calculation under subsection (b), and

therefore within the definition of “Monthly Payments.” There is of course a fine line

between interpreting the Note and reforming it to say what it could not reasonably be

interpreted to say before. See Long, 208 Ariz. at 329, 93 P.3d at 529 (“As Taylor

recognizes, . . . one cannot claim that one is ‘interpreting’ a written clause with extrinsic

evidence if the resulting ‘interpretation’ unavoidably changes the meaning of the

writing . . . .”); see also 5-24 CORBIN ON CONTRACTS § 24.18 (“[R]eformation is sought

because although the parties have assented to the very words contained in the document,

these words were so ill chosen as to produce an unintended legal effect . . . .”). However,

in such a close case, it cannot be said that interpreting the term “Monthly Payment” to

include the final balloon payment crosses the line from interpretation to reformation, at

least where the parties’ actual intention from the negotiations is as explicit and undisputed

as it is here. Therefore, the term “Monthly Payments” in subsection (b) of the

prepayment premium formula under the Note includes the final balloon payment due on

the maturity date.

B. Enforceability of the Prepayment Premium under Lincoln’s

Interpretation

UIP argues that if Lincoln’s interpretation is correct, the resulting prepayment

premium of $678,000 is unenforceable. Although unclear in the briefing, UIP appears to

be challenging the enforceability of the premium on two grounds: (1) the premium is an

unenforceable penalty and (2) the premium is unconscionable.

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1. The prepayment premium provision cannot be an unenforceable

penalty because it is not a liquidated damages provision.

In support of its argument that the resulting premium is an unenforceable penalty,

UIP cites to several bankruptcy court decisions in which the enforceability of prepayment

premium provisions was analyzed under a liquidated damages framework. See In re A.J.

Lane & Co., 113 B.R. 821 (Bankr. D. Mass. 1990); In re Kroh Bros. Dev. Co., 88 B.R.

997 (Bankr. W.D. Mo. 1988); In re Skyler Ridge, 80 B.R. 500 (Bankr. C.D. Cal. 1987).

Lincoln, on the other hand, relies on several non-bankruptcy decisions to support its

argument that the prepayment premium provision is not a liquidated damages provision

and therefore should not be analyzed as one. See Great Plains Real Estate Dev., L.L.C. v.

Union Cent. Life Ins. Co., 536 F.3d 939 (8th Cir. 2008); West Raleigh Group v. Mass.

Mut. Life Ins. Co., 809 F. Supp. 384 (E.D.N.C. 1992); Ridgley v. Topa Thrift & Loan

Ass’n, 73 Cal. Rptr. 2d 378, 953 P.2d 484 (1998); Carlyle Apartments Joint Venture v.

AIG Life Ins. Co., 333 Md. 265, 635 A.2d 366 (1994).

Arizona law recognizes that “[t]he traditional role of liquidated damages

provisions is to serve as an economical alternative to the costly and lengthy litigation

involved in a conventional breach of contract action . . . .” Pima Sav. & Loan Ass’n v.

Rampello, 168 Ariz. 297, 299, 812 P.2d 1115, 1117 (Ct. App. 1991). Therefore, it

follows that a contract provision is a liquidated damages provision only if it is triggered

by an event that qualifies as a breach of the contract. If a party is merely exercising an

alternative method of performance provided for in the contract, there is no breach of the

contract. See Great Plains, 536 F.3d at 945. 

Depending on how they are drafted and the facts of a particular case, prepayment

provisions may be triggered either by the borrower’s exercise of a contractual right to

prepay or by the borrower’s attempt to pay after default and acceleration. Prepayment

provisions often allow the borrower to pay off the loan before the maturity date if the

borrower pays a prepayment premium along with the outstanding balance of the loan. 

See, e.g., Great Plains, 536 F.3d at 943; Atl. Ltd. P’ship-XI v. John Hancock Mut. Life

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Ins. Co., 95 F. Supp. 2d 678, 679-80 (E.D. Mich. 2000); West Raleigh Group, 809 F.

Supp. at 386; Carlyle, 333 Md. at 266-67, 635 A.2d at 366-67. The provision is therefore

triggered when the borrower exercises the bargained-for right to an alternative method of

performance. 

However, to prevent a borrower from circumventing a prepayment premium, or to

compensate a lender in the event of default, prepayment premiums may also be triggered

when the borrower attempts to pay off the loan after default and/or acceleration. See, e.g.,

In re CP Holdings, Inc., 332 B.R. 380, 382-83 (W.D. Mo. 2005) (prepayment premium

triggered by acceleration of the note); A.J. Lane, 113 B.R. at 822-23 (prepayment

premium triggered by borrower’s attempt to pay the loan after default); Kroh, 88 B.R. at

998 (prepayment premium triggered by borrower’s default); Skyler Ridge, 80 B.R. at 501-

02 (prepayment premium triggered by borrower’s attempt to pay off the loan after

default).

This distinction likely explains the divergent conclusions among courts as to

whether a prepayment provision should be analyzed as a liquidated damages provision. 

In all the bankruptcy cases cited by UIP, the prepayment provision appears to have been

triggered by the borrower’s default. In such cases, the prepayment provision was a

liquidated damages clause because it was triggered by a breach of contract. See Kroh, 88

B.R. at 999 (recognizing that liquidated damages clauses attempt to forecast harm caused

by a breach of the contract). However, even in those cases, at least one court has

expressed doubt as to whether prepayment provisions should be analyzed as liquidated

damages clauses. See Skyler Ridge, 80 B.R. at 503 (“The classification of the prepayment

premium language as a liquidated damages provision is not altogether certain. However,

the parties have agreed upon this characterization . . . .”). 

On the other hand, in almost all the cases cited by Lincoln, the provision was

triggered by the borrower’s decision to exercise a contractual option to prepay the loan. 

The liquidated damages analysis was ill-suited to these cases because there was no breach

of contract. See Great Plains, 536 F.3d at 945 (declining to treat a prepayment provision

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as a liquidated damages clause because when plaintiff chose to prepay, it “was not

breaching the contract but was in fact acting in accordance with an express option

provided under the contract”); West Raleigh Group, 809 F. Supp. at 391 (deciding that the

prepayment premium was the “bargained-for consideration for the option to prepay, and

as such . . . enforceable as a matter of contract law and not as a measure of damages”);

Carlyle, 333 Md. at 270, 635 A.2d at 368 (concluding that the facts did not “engage the

gears of . . . law relating to liquidated damages” because the plaintiff complied with the

terms of the prepayment provision and did not breach the contract). As some nonbankruptcy courts have acknowledged, the bankruptcy context is distinguishable because

it almost always involves a breach of contractual payment obligations and it requires

prepayment provisions to be assessed with competing creditors’ claims in mind. See

Norcrest, Inc. v. Collateral Mortgage Capital LLC, No. 06-6025-CV-SJ-HFS, 2008 WL

4279595, at *1, 2008 U.S. Dist. LEXIS 68834, at *3 (W.D. Mo. Sept. 11, 2008) (“The

bankruptcy context, where there is a breach of payment obligations, is not identical to a

situation where, as here, a prepayment occurs pursuant to contractual provisions.”); Atl.

Ltd. P’ship-XI, 95 F. Supp. 2d at 684 (“Bankruptcy courts approach the issue of

prepayment premiums from a different perspective . . . .”). 

In this case, the prepayment provision gives UIP the option to prepay the loan so

long as it pays a prepayment premium. However, the provision also requires UIP to pay a

premium if it defaults and attempts to pay the outstanding balance upon acceleration. 

Therefore, the provision in this case may be triggered by the voluntary choice to prepay

the loan, or by a breach of the Note followed by acceleration. Whether the provision

should be treated as a liquidated damages clause could be affected by whether the

provision was crafted primarily to provide an alternative method of performance or

primarily to compensate for loss associated with a breach. Here, the provision was

clearly intended to provide UIP with an alternative method of performance, because it

starts out by stating that “Maker may prepay this Note in whole . . . provided Maker gives

Holder . . . written notice . . . and pays a prepayment fee . . . .” Much later, the provision

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goes on to state that an attempt by UIP to pay off the loan after default and acceleration

“shall be presumed to be and conclusively deemed to constitute a deliberate evasion of

the prepayment provisions . . . and shall therefore be subject to the Prepayment

Premium . . . .” The goal of allowing the premium to be triggered by default was not

primarily to compensate Lincoln for damages from involuntary default, but rather to

remove the incentive for UIP to evade the premium. Furthermore, in this case, the

provision was triggered by UIP’s election to prepay the loan. It was not triggered by a

default or other breach of the terms of the Note. Therefore, the provision is not a

liquidated damages provision and is not subject to the analysis governing unenforceable

penalties. 

2. The prepayment premium is not unconscionable.

UIP argues in the alternative that the $678,000 prepayment premium under

Lincoln’s interpretation is unconscionable. This argument fails for several reasons. First,

UIP has provided no legal authority or facts to support an argument that the prepayment

premium in this case would be unconscionable. Second, as other courts have recognized,

prepayment of a loan is not a right or an obligation, but rather an optional contractual

privilege given to the borrower by the lender. See Norwest Bank Minn., N.A. v. Blair Rd.

Associates, L.P., 252 F. Supp. 2d 86, 97 (D.N.J. 2003) (“Under New Jersey law unless the

note gives the borrower the right to prepay the loan, the borrower is obliged to pay the

full amount of the interest that he would have to pay over the term of the loan.”);

Northway Lanes v. Hackley Union Nat’l Bank & Trust Co., 334 F. Supp. 723, 732 (W.D.

Mich. 1971) (“[A]bsent agreement to the contrary, the lender has a right to refuse

prepayment altogether and to insist that a note and interest be paid according to its

terms . . . .”). The prepayment premium cannot be unconscionable where UIP can simply

avoid it by continuing to pay off the loan to maturity. See id.

IT IS THEREFORE ORDERED that the parties’ cross-motions for summary

judgment (doc. ## 52, 60), converted to a bench trial upon stipulation of the parties, are

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decided in favor of Defendant Lincoln National Life Insurance Company and against

Plaintiff UIP Limited, L.L.C.

IT IS FURTHER ORDERED that the Clerk enter final judgment declaring that the

term “Monthly Payments” in the promissory note includes the final balloon payment due

on the maturity date, such that the present value of the final balloon payment is included

in the calculation under subsection (b) of the prepayment premium formula in the

promissory note. The Clerk shall terminate this action.

DATED this 30th day of November, 2009.

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