Planned Pethood Plus, Inc. v. KeyCorp, Inc.
228 P.3d 262, 2010 WL 185414, 2010 Colo. App. LEXIS 56 (2010)
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Rule of Law:
A prepayment penalty in a commercial loan agreement is not a liquidated damages clause when the borrower voluntarily prepays the loan, as this constitutes an alternative performance under the contract, not a breach. Such a clause is enforceable unless it is found to be unconscionable.
Facts:
- Planned Pethood Plus, Inc. (Pethood), a veterinary clinic owned by two veterinarians, obtained a 10-year, $389,000 commercial loan from KeyCorp, Inc. (Keybank) at a fixed interest rate.
- The promissory note for the loan contained a prominently displayed clause allowing for prepayment but requiring a penalty if this option was exercised.
- The veterinarians, who had previously negotiated at least four commercial loans, signed the note, acknowledging they had read and understood its terms, though one later claimed not to have read it and the other not to have understood it.
- Pethood made all loan payments on time.
- Eight years and eight months before the loan's maturity date, Pethood voluntarily chose to prepay the entire outstanding principal.
- Keybank invoked the prepayment clause and required Pethood to pay a penalty of $40,525.72 to obtain the release of the deed of trust securing the loan.
- Pethood paid the penalty under protest.
Procedural Posture:
- Planned Pethood Plus, Inc. filed suit against KeyCorp, Inc. in the district court (trial court) seeking recovery of the prepayment penalty.
- The parties filed cross-motions for summary judgment.
- The district court granted summary judgment in favor of Keybank and against Pethood.
- Pethood, as the appellant, appealed the district court's judgment to the intermediate court of appeals.
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Issue:
Does a prepayment penalty clause in a commercial promissory note constitute an unenforceable liquidated damages penalty when a borrower voluntarily elects to prepay the loan in full before its maturity date?
Opinions:
Majority - Judge Booras
No. A prepayment penalty clause is not an unenforceable liquidated damages penalty when voluntarily triggered by a borrower because it represents a bargained-for alternative form of performance, not a remedy for a breach of contract. Liquidated damages law applies only when there is a breach, which did not occur here. Pethood exercised a contractual right to prepay, and the penalty was the agreed-upon price for that right. This is consistent with the common law principle that a borrower has no inherent right to prepay a loan; it must be a contractually granted privilege. Furthermore, the clause is not unconscionable because the penalty amount (10.72%) is not excessive compared to precedent, the clause was prominently displayed, and the borrowers were sophisticated parties. Enforcing the agreed-upon term does not create a 'profound sense of injustice.'
Analysis:
This decision solidifies the distinction between remedies for breach of contract and provisions for alternative performance. It establishes in Colorado that a voluntary prepayment fee in a commercial loan is not a penalty to be analyzed under liquidated damages standards, but rather the price for a contractual option. This holding protects lenders' interest rate expectations and reinforces the principle of freedom of contract, particularly between sophisticated commercial entities. Future challenges to such fees will likely fail unless they can meet the high bar of unconscionability, focusing on procedural fairness and substantive shock rather than a simple reasonableness test of damages.
