In Re CP Holdings, Inc.

Citations: 332 B.R. 380; 2005 WL 2428323Docket: 19-20220

Court: United States Bankruptcy Court, W.D. Missouri; September 30, 2005; Us Bankruptcy; United States Bankruptcy Court

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CP Holdings, Inc. appealed a final order from the U.S. Bankruptcy Court for the Western District of Missouri, which overruled its objection to a claim made by the California Public Employees' Retirement System (CALPERS). The objection was based on a prepayment premium included in CALPERS' claim, which CP Holdings argued was a penalty rather than compensation for loss. The District Court, upon review of the case and the Bankruptcy Court's findings, affirmed the lower court's decision, concluding there was no error in allowing the prepayment premium. 

The case revolves around the interpretation of a prepayment penalty clause in a secured promissory note executed by CP Holdings in 1989 for $12 million, which was later assigned to CALPERS. The note, secured by mortgages on commercial properties in Missouri, Maryland, and Michigan, stipulates that if CALPERS accelerates the note, CP Holdings waives the right to prepay without incurring a prepayment premium. The premium is calculated as the greater of 1% of the principal or a formula based on the reinvestment yield minus the present value of the mortgage payments. The calculation involves determining a comparable U.S. Treasury yield and the present value of the remaining payments, adjusted for any prepayment. The court confirmed the validity of these provisions and the basis for CALPERS' claim.

On April 18, 2003, CALPERS accelerated the Note, declaring the full balance immediately due, an action not contested by CP Holdings. CALPERS calculated a prepayment premium of $2,651,547.69 by first determining a Reinvestment Yield of 3.875 from a ten-year Treasury yield published two weeks prior to acceleration. This yield was converted to a monthly rate, and remaining payments were discounted to establish a present value of $11,102,760.49. After subtracting the principal balance due as of April 1, 2003, the prepayment premium was computed. CP Holdings filed for Chapter 11 on June 13, 2003, without having prepaid any debt. On October 14, 2003, CP Holdings objected to CALPERS' proof of claim, arguing the prepayment premium did not reflect CALPERS' actual damages. A hearing was held on April 30, 2004, where both sides presented expert testimony regarding the prepayment premium's purpose, commonality in commercial lending, and its reasonableness. The Bankruptcy Court found the acceleration occurred before the bankruptcy petition and determined the claim amount based on the Note's language, stating that Bankruptcy Code § 506(b) did not apply since it pertains to claims post-petition. The Court upheld the prepayment premium as a reasonable estimate of damages, citing the reliability of the Treasury rate used in the formula. CP Holdings challenged this decision on three grounds: the obligation to pay a prepayment premium lacked basis without an actual prepayment, the formula was not a valid liquidated damages clause under state law as it did not accurately forecast damages, and the prepayment premium should be disallowed under Bankruptcy Code § 506(b) for being unreasonable and unsupported by actual damages. CP Holdings filed a timely appeal from the Bankruptcy Court's final order, with jurisdiction established under 28 U.S.C. § 158(a)(1).

The standard of review for interpreting the terms of a promissory note and their legal implications is de novo, as established by case law. If the district court's interpretation is based solely on the contract terms, it is subject to plenary review. However, if the Bankruptcy Court's interpretation relies on disputed extrinsic evidence, a clearly erroneous standard applies. A finding is clearly erroneous only if the court has a strong conviction that a mistake has occurred. 

The Bankruptcy Court ruled that CP Holdings was obligated to pay a prepayment premium to CALPERS following the acceleration of the Note. CP Holdings argued that since it had not made a prepayment after the acceleration, it should not owe the premium. However, the Bankruptcy Court found the language of the Note to be clear, indicating that upon acceleration, CP Holdings waived the right to prepay without incurring a premium. The Note specifies the calculation method for the prepayment premium, which includes a formula based on reinvestment yield. CALPERS calculated this yield to be 3.875%, based on a Treasury issue published two weeks prior to the acceleration date, adhering to the terms of the Note for calculating the premium.

Patrick A. Randolph, Jr., an expert for CALPERS, testified that a prepayment premium clause is included in loans to protect lenders from losing expected income due to borrower defaults, particularly when the loan balance is accelerated. He explained that the acceleration date marks the point when the lender begins to incur losses in its income stream, making it the appropriate date for calculating reinvestment yield. During cross-examination, Randolph noted that the formula for the prepayment penalty, which references the yield on U.S. Treasury issues prior to prepayment, should have explicitly used "acceleration" instead of "prepayment." He argued that this change would clarify the intent to consider acceleration as the moment of prepayment in cases of borrower default. Although he acknowledged that "acceleration" and "prepayment" are not interchangeable in other contexts, he emphasized that the Note lacks a clear statement equating the two terms. The Bankruptcy Court ultimately overruled CP Holdings' objection to CALPERS' proof of claim, suggesting it was influenced by Randolph's testimony regarding the intent to use the acceleration date for calculating the prepayment premium. Consequently, the court upheld CALPERS' claim for a prepayment premium of $2,651,547.69, as it found no clear error in the Bankruptcy Court's determination based on Randolph's testimony.

The parties agreed to a prepayment premium to protect CALPERS from loss of interest income in case of CP Holdings' default and subsequent acceleration of the Note. Contract interpretation focuses on the parties' intent, which the Bankruptcy Court correctly considered while interpreting the Note's terms. The court's ruling allowing CALPERS to recover the prepayment premium based on the acceleration date is justified by a holistic view of the Note and mortgage instruments. Contracts must be read in their entirety to ensure no provisions are rendered meaningless. The Note obligates CP Holdings to pay a prepayment premium upon acceleration. According to the mortgage, upon default, the principal and accrued interest become immediately due, along with the prepayment premium calculated per the relevant provision. CP Holdings' argument against the obligation to pay a prepayment premium post-acceleration contradicts the mortgage terms, as interest accrues on the entire balance until fully paid, which would be undermined if the premium were calculated only at prepayment. Furthermore, if the premium could not be calculated at the time of acceleration, it would not be payable immediately, thus contradicting the agreement's intent. The Bankruptcy Court's decision aligns with the need to harmonize the Note and mortgage provisions.

The Bankruptcy Court determined that the date of acceleration should be used to calculate the prepayment premium instead of the date of prepayment. This finding is supported by case law, which treats acceleration as a form of prepayment due to the resultant loss of expected payment streams for the lender. CALPERS lost interest payments upon acceleration, justifying the court's reliance on this date for computing reinvestment yield in the absence of prepayment. The prepayment premium clause in the Note was deemed to obligate CP Holdings to remit a premium at the time of acceleration. CP Holdings did not successfully challenge the court's reliance on Randolph's testimony regarding the clause's intent, which was corroborated by the mortgage instrument and similar decisions in other bankruptcy cases.

Moreover, the court upheld the validity of the prepayment premium clause as a liquidated damages provision under state law, countering CP Holdings' argument that the formula was not a reasonable forecast of damages. In Missouri, liquidated damages clauses must predict damages accurately at the contract's inception and address harms difficult to estimate. The court found the prepayment premium formula to be a reasonable estimate of potential damages from acceleration, supported by expert testimony indicating its relation to anticipated losses. The use of the U.S. Treasury rate in the formula was justified as reliable and commonly accepted in such agreements.

The Court concurs with Judge Federman's determination that the prepayment premium formula in the Note constitutes a valid liquidated damages clause under state law. Expert testimony from CP Holdings' Christopher C. Pflaum indicated that such clauses are standard in commercial lending, describing the current clause as "plain vanilla." Pflaum noted minimal variations among typical prepayment premium calculations, highlighting that the prevalent formula involves the net present value of future cash flows discounted at the Treasury Bond yield corresponding to the loan's average life. He asserted that obtaining a $12 million loan in 1989 without such a clause would likely have incurred additional costs, and he deemed the clause itself reasonable as it does not deter borrowers from refinancing.

CALPERS' expert, Randolph, corroborated that the prepayment clause aligns with common industry practices in 1989 and serves as a reasonable protective measure for lenders against the risks of replacing their income stream. Randolph justified the use of the Treasury yield as a stable benchmark for calculating the prepayment premium, emphasizing its reliability amid potential fluctuations in commercial loan rates. The Court finds the Bankruptcy Court's ruling that the prepayment premium clause is a valid liquidated damages clause is well-supported by the evidence, with both experts agreeing on the clause's commonality and reasonableness, thereby inferring it was a fair forecast of anticipated harm at the time of contracting.

The Court determined that the prepayment premium clause constituted a reasonable forecast of potential harm from acceleration at the time of contract formation. CP Holdings contended that the formula's reliance on the yield of a U.S. Treasury issue was unreasonable, suggesting instead that a higher yield from commercial first-mortgage loans should have been used, which would reduce the prepayment premium to $1.25 million. The Court rejected this argument, emphasizing two main points: first, altering the agreed-upon yield would violate the principle of freedom of contract since both parties, being sophisticated business entities, had specifically chosen the U.S. Treasury yield for the calculation. Second, expert testimony indicated that the U.S. Treasury yield is a stable and secure interest rate, making it a reasonable basis for estimating damages. The Court also acknowledged the inherent difficulty in accurately estimating damages from acceleration due to various unpredictable factors, including loan amount, remaining term, and market conditions. As a result, the liquidated damages clause was deemed valid and enforceable, affirming that the challenges of predicting potential losses at the time of contracting justified the use of the prepayment premium formula.

CP Holdings failed to demonstrate that the Bankruptcy Court erred in ruling that Bankruptcy Code, Section 506(b) does not apply to the prepayment premium in the Note. The Bankruptcy Court clarified that Section 506(b) is only relevant for assessing claims incurred post-petition, noting that the prepayment premium became due at the time of acceleration—prior to the bankruptcy filing—making it part of CALPERS' claim before bankruptcy. Various bankruptcy courts have interpreted Section 506(b) to only apply to post-petition claims for fees, costs, or charges, affirming that pre-petition amounts are included in the secured creditor's claim and not governed by 506(b). CP Holdings did not cite any case supporting that a prepayment premium due before bankruptcy is subject to 506(b), instead referencing cases concerning post-petition attorney fees which are not applicable here. The Court upheld the Bankruptcy Court's finding that the prepayment premium was valid and enforceable as a liquidated damages clause under state law, affirming the decision that Section 506(b) does not apply to CALPERS' prepayment premium claim. The Bankruptcy Court's Order overruling CP Holdings' objection is affirmed.

The yield on the ten-year Treasury must be adjusted to a monthly basis due to semi-annual payments. CALPERS initially claimed a prepayment premium of $2,620,731.32 but later revised it to $2,651,547.69. During the hearing, CALPERS utilized a yield of 3.875 from a ten-year Treasury published on February 13, 2003, in the Wall Street Journal for its reinvestment yield calculation. The Court verified this yield against historical Federal Reserve data, which indicated a yield of 3.89 on that date and 3.83 on March 31, 2003, shortly before the acceleration date. Although CALPERS calculated the penalty based on the February yield, the argument to disallow the prepayment premium due to the alleged incorrect application of the Treasury yield was not raised in Court and thus will not be addressed.