Law advises landowners to make use of property

When I was a youngster, my mother always told me “You can’t get something for nothing.”  Mother, bless her heart, obviously didn’t own much real estate.

What mother didn’t know is that almost all real estate—even the old family homestead—is at risk from what is known as a “prescriptive easement.”

The policy of the law is to favor the actual use of real estate.  The law, in proper situations, also favors certainty in the use of real estate.  What all this means is that in real estate, owners must either “use it or lose it.”  And for non-owners, the policy can be “use it—and get it.”

An owner, who doesn’t use real estate for five years, may lose ownership if a stranger occupies the property for those five years and pays the taxes on it. This principle is known as “adverse possession.”  If the owner pays the taxes each year, then he or she can’t lose ownership of the property.

However, if someone else uses the property, that person may gain a “prescriptive easement.”  This “easement” is an actual ownership interest in the property.  It doesn’t exclude the owner, which means the owner can continue using the property.  But if the occupant gets an easement, then the occupant has a legal right to continue using the property.  The owner may not be able to exclude the occupant or stop him or her from using the property.

The process for obtaining a prescriptive easement is similar to the process for obtaining title to property through adverse possession.  However, an occupant need not pay taxes to get a prescriptive easement unless the easement has taxes separately assessed.

In order to get a prescriptive easement, an occupant must occupy the property for five years.  The occupant doesn’t have to live on the property or stay on it.  Even driving over a road when needed may be sufficient as long as the owner doesn’t give permission and as long as the use is sufficiently open that the owner can observe it.

After five years of such use, the occupant, or user, holds an “easement by prescription.” This easement isn’t ownership, but it is a right to use the property.

Obtaining a prescriptive easement might look appealing.  But persons who unlawfully and without permission enter property belonging to someone else can be guilty of a trespass.  As a result, the obtaining of a prescriptive easement can in some cases result in potential trespass problems.

To protect themselves from potential claims of easement, owners can post signs at each entrance to their property and at certain intervals along the boundary.  These signs say “Right to pass by permission, and subject to control, of owner: Section 1008, Civil Code.”  When done properly, these signs can prevent users or occupants from gaining an easement in the property.  However, property owners do well to seek professional legal counsel before placing such signs, because the law contains specific requirements for such signs to be effective.

Unreasonable Music

As defined by Webster’s II New College Dictionary, the word “nuisance” means “something that is inconvenient or vexatious: bother.”  That’s a concept that’s easily understood – when something (or someone) is a nuisance, then there’s an annoyance, or a bother.

But there’s a slightly different meaning in the law.  Webster’s also notes that in a legal context, a “nuisance” is “a use of property or course of conduct that interferes with the legal rights of others by causing damage, annoyance, or inconvenience.”

These two definitions are the only two definitions of the word “nuisance” that is given in Webster’s II New College Dictionary.

There are many kinds of dictionaries.  In addition to dictionaries of English words (such as Webster’s) there are also dictionaries that define and describe specialty words.  For example, Means Illustratrated Construction Dictionary gives definitions (and pictures) of many different kinds of construction terms.  And it’s possible for anyone to purchase Mosby’s Dictionary of Medicine, Nursing & Health Professions.

There are also Legal Dictionaries that define legal terms, words and phrases.  One of these is Black’s Law Dictionary (seventh edition).  Black’s definitions of “nuisance” occupies more than a one and a half pages of text.  That’s a fairly clear indicator that “nuisance” is a concept that is pretty well developed in the law.  Black’s defines “nuisance” as “A condition or situation (such as a loud noise or foul odor) that interferes with the use or enjoyment of property.  Black’s notes that a “nuisance” isn’t necessarily something that is offensive to all people.  For example, Black’s cites a United States Supreme Court case from 1926 for an example of a nuisance: “A nuisance may be merely a right thing in the wrong place, like a pig in the parlor instead of the barnyard.”  But Black’s also observes that the concept of “nuisance” has a wide range of applications.  “There is perhaps no more impenetrable jungle in the entire law than that which surrounds the word ‘nuisance.’  It has meant all things to all people, and has been applied indiscriminately to everything from an alarming advertisement to a cockroach baked in a pie.” (The original source of this statement is a famous legal work entitled “Prosser and Keeton on the Law of Torts §86, at 616.”)

The concept of “nuisance” is not new.  It’s been around for many, many years.  In an entertaining case from 1939, a New York court described as follows one particular case of nuisance “Claremont Inn, at 124th Street and Riverside Drive, is an old institution rich in historical incident. Acquired by the City in 1872, it has been under the jurisdiction of the Park Department, leased at various times to private persons to conduct as a place of refreshment. Renovated in 1934, it was converted from an expensive to a popular establishment. It consists of an indoor restaurant and bar and also a large outdoor pavilion with an outdoor modern dance orchestra. The outdoor section is open from about June 1st to the end of September. And the band plays from 7 P. M. to 1 A. M. (on Saturdays and holidays to 2 A. M.). It is noteworthy that this is the only open air dance orchestra in a residential section in any part of the City.”

The neighbors filed a lawsuit, asking the New York Court to order the Inn to close earlier each night due to “loud music, excessive noise, heedless conduct of its operators and boisterous behavior of its patrons.”  The court noted that “Assurances have been given for the correction of many of the offending practices, such as rehearsals of the orchestra at 3 A. M.; the removal of refuse cans, and deliveries by tradespeople, with attendant clatter and rumbling of trucks, early in the morning; and congested traffic and parking, with resulting clamor and shouting, when the patrons of the Inn depart. But the defendants insist upon continuing the outdoor band to the hours above specified—and the residents of the district, claiming that their sleep is disturbed, insist on an earlier hour.”  The case is reported as Peters v. Moses (1939) 12 N.Y.S.2d 735.

This was evidently quite an event each evening.  The outdoor dance floor was located in a residential neighborhood.  The dance band held rehearsals at 3 a.m.  The band played until 1:00 a.m. each evening, except for weekends when it played until 2:00 a.m.  With all of the noise, disturbance, and clamour of an outdoor dance, the neighboring residents were understandably up in arms.

Open House Has Surprising Result

            On any given summer weekend, it’s possible to drive around suburban neighborhoods and see realtor signs out on the sidewalk.  It’s a known fact: Realtors hold open houses.  These open houses can be a great opportunity for buyers of real estate to check out a neighborhood, check out a potential new home, or even check out a realtor.  No appointment is necessary – all you have to do is get in a car, find an area you like and start driving.  If you’re lucky, you might even score some refreshments.

The history of theft, fraud, and abuse is as old as mankind.  Stories of theft, fraud and abuse go all the way back to the earliest recorded histories.  So it’s no surprise that sometimes people come up with new ways of doing an old thing – which is trying to get something for nothing; an effort to get something without working for it and without paying for it.  The problem is, people who try to make a fast buck illegally often underestimate the true costs of such activities – the emotional drain they experience from working outside the law, the risk and fear of getting caught, always looking over their shoulder, and then ultimately the consequences if and when they do get caught. It’s just bad every which way.

In the old days, Burglary was sometimes defined as breaking and entering into another’s dwelling at night with the intent to commit a felony.  The modern law is usually not so limited.  Burglary is no longer usually limited to an entry at night, and Burglary is generally no longer limited to entry into residential properties.  Therefore, an unauthorized entry into a commercial property with an intent to commit any larceny (i.e. theft) or with an intent to commit any felony can qualify as burglary.  Most people probably think of a burglar as someone who unlawfully enters into a property with the intent to steal something.  This might be the most common result of burglary – a theft of something — but a burglary can also exist where there’s an intent to commit any felony.

Differing degrees of burglary exist.  First degree burglary generally includes burglary of an inhabited dwelling house, or an inhabited floating home, or an inhabited trailer coach, or the portion of any building which is inhabited.  Second degree burglary is any burglary which is not first degree burglary.  There’s a long history in the development of the law concerning burglary.  These definitions aren’t the full story concerning burglary – but they are a starting point.

It seems that in June of 2010, a realtor was holding an open house in California.  Two individuals attended the open house.  Once inside the property being shown, the individuals split up.  One of the individuals spoke with the realtor for several minutes, and the other disappeared for a few minutes inside the property.

After the individuals left the house, the realtor realized her wallet was missing. Her wallet contained several credit cards, a gift certificate, and a lottery ticket.  The realtor looked about the property and her car for her wallet, and contacted her roommate at home to see if she had left the purse at home.  She couldn’t locate the wallet, and so she called the police.

An on-duty police Sergeant heard the radio dispatch about the stolen wallet while he was out working in the field.  He spotted a pickup truck that matched the description from the dispatch.  He made a traffic stop, searched the pickup truck and found the realtor’s credit cards in between the seats.  The realtor made a positive identification of the persons in the pickup truck.

One of the suspects was charged, and after trial was convicted, of first degree residential burglary, second degree commercial burglary and fraudulently using an access card.  On appeal, this individual claimed, among other things, that he was not guilty of first degree residential burglary because the occupants of the house were not present at the home at the time he was there.  He argued that first degree burglary can only exist for a dwelling which is occupied, and that because the residents weren’t there at the time of the open house, the property wasn’t “inhabited.”

The court of appeal disagreed, and found that the property was “inhabited” but that the occupants were “temporarily absent” at the time of the open house.  The court of appeal affirmed the judgment of conviction.

The single theft of the wallet from inside a residential property resulted in the individual being convicted of three crimes, one of which was first degree residential burglary.  It was a high price to pay for stealing a wallet.  The defendant was sentenced to 21 years and 4 months.

The case is reported as People v. Little (2012) DJDAR 7965.

This article only summarizes some of the main points of this case.  The complete facts and law involved in this case are more detailed and complex than those summarized here.  Nothing in this article should be relied on in any specific situation, because the considerations in any specific situation may require different considerations or may provide a different result.  Persons with questions or issues concerning the legal issues raised in this column should consult competent legal counsel.

Options Exist for Check Problems

With the continuing popularity of online banking and the widespread use of credit  and debit cards, it seems like virtually all transactions these days are being done electronically.  But some large transactions are still done mostly by check.

A good example of this is the sale of real estate.  Most real estate sales involve an “escrow holder.”  This “escrow holder” accepts instructions from both the Buyer and the Seller.  The Seller deposits a deed into escrow and the Buyer (or the Buyer’s lender) deposits the purchase price into the escrow.  When the escrow holder can fully comply with the instructions from the Buyer and the Seller, then the “escrow” is closed, the deed is recorded and the Buyer’s money is given to the Seller.

Most often the purchase money is given to the Seller in the form of a check.  So what happens if the Seller takes the check, goes out to dinner to celebrate the sale, but leaves the check in the restaurant with their purse or wallet?  What if the check is lost or stolen?  Can the Seller do anything about this?

The answer is “Yes.”  In that situation, the Seller can contact the escrow holder and request that a “stop payment” be issued on the check.  The escrow holder can contact its bank and ask that the check not be honored.  A verbal “stop payment” is generally valid for 14 days.  If a letter is sent, then such a stop payment request is usually valid for 6 months.  As long as the bank is given sufficient notice to act on the sop payment request, then the Bank can’t properly honor the check if a valid stop payment request has been made.  If the bank honors the check after receiving a valid stop payment request then the bank may be liable for any loss or damage that results from any wrongful payment by the bank on the check.

This isn’t to say that persons receiving checks should plan to rely on a stop payment order if they lose a check.  Mistakes happen, and sometimes checks are honored when they shouldn’t be.  If a bank mistakenly pays a check subject to a stop order, the person who lost the check may be unable to get a replacement from the check issuer and this person may need to rely on the bank for repayment.

The bank may resist making such a payment and an expensive lawsuit may be necessary.  Further, if the stop payment was only verbal, there may be no record of the stop payment and the bank may dispute when or whether such a stop payment request was validly made.

Therefore, in order to avoid a real headache situation, the best policy with respect to checks is to treat them like cash.

Original Promissory Note May Not Be Necessary in Foreclosure

Nothing ventured, nothing gained.

With the unprecedented number of foreclosures that have been occurring over the past few years, borrowers in default on their loans have been faced with the unpleasant – and very real – prospect of losing their homes in foreclosure.

When presented with the likelihood of foreclosure, some borrowers have chosen to sell their properties through a “short sale.”  Others have chosen to simply abandon their homes and allow the foreclosure sale to occur.  Other borrowers have ended up in bankruptcy.

Some borrowers have taken a very creative approach in dealing with a potential foreclosure.  In one case, a homeowner in default chose to file a lawsuit against a lender by claiming that the lender had no right to foreclose because the lender didn’t have the original promissory note. This case was determined by a federal court, and it is identified as Sicairos v. NDEX West, LLC, 2009 WL 385855 (S.D. Cal.)   A “promissory note” is a written promise to pay money, and many loan agreements are evidenced by a promissory note.  In general, a creditor who holds a promissory note should be able to prove that such creditor actually owns the loan by producing the original promissory note.

Home loans get bought and sold by lenders every day.  Sometimes the paper trail is imperfect, and as a result the loan may be transferred to a purchasing bank, but the original promissory note may get lost in the shuffle.  The homeowner in the Sicairos case claimed that because the bank didn’t have the original promissory note, it wasn’t entitled to foreclose on the borrower’s home. But the homeowner’s attorney didn’t have any real legal authority that required the foreclosing lender to actually have the original promissory note.  In the Sicairos case, the court held that California law doesn’t require a lender to actually have physical possession of the original promissory note in order to conduct foreclosure proceedings. The Sicairos court found that California law provides a comprehensive procedures for non-judicial foreclosures, and the Sicairos court wasn’t able to identify anything in the foreclosure statutes that required the lender to actually have the original promissory note.

Some borrower may wonder whether or not they might have a good defense to foreclosure if their lender hasn’t kept a perfect paper trail.  The plaintiff in the Sicairos case certainly made a game effort to halt foreclosure based on this technicality.  But in this case, the court wasn’t impressed, and it dismissed the homeowner’s lawsuit, thereby allowing the lender to proceed with foreclosure.

The Sicairos case was decided by a federal trial court.  This decision wouldn’t be binding on California state courts, nor would it be binding on most other federal courts, including bankruptcy courts.  Sometimes technical arguments can be successful in legal matters. And a different court could potentially have reached a different result.  But in this case, this technical argument failed.

Owners Must Maintain Some Properties

                The number of foreclosures in the late 2000’s was very, very high. Californians probably haven’t seen this many foreclosure sales since the Great Depression of the 1930’s.

Besides the economic upheaval experienced by families in foreclosure, some owners of neighboring properties found that their own properties were being negatively affected by “foreclosure blight.”  If a foreclosed property is left vacant and not maintained, the yard can quickly get out of hand.  Because the foreclosure process takes several months to complete, and because lenders are often delaying foreclosure during workout or short-sale negotiations, a vacant property can quickly become an eyesore.  Properties sold at foreclosure sale can be purchased by investors who don’t move into the property, but who instead hold the property vacant for investment purposes.  Because these owners don’t actually live in the property, they sometimes have an economic disincentive to maintain such properties.

Recognizing that such properties can have negative effects on neighborhood property values, the California Legislature passed a law in 2008 that gives local government the power to address such problems.  Normally, a homeowner isn’t required to cut his or her grass.  And before 2008, there was no law that required a homeowner to trim or prune trees or shrubs so long as sidewalks, roads, and neighboring properties aren’t directly affected and so long as the public health and safety isn’t negatively affected.  But in 2008, the California Legislature passed Civil Code section 2929.3.  That law provides that persons who purchase a property at a foreclosure sale must maintain that property so long as it remains vacant.  If the owner of such property fails to maintain it, then the city or other local governmental entity can assess fines of up to $1,000 per day for each violation.

That’s a substantial fine for not cutting your grass.  If you leave your grass uncut for 30 days, you could end up paying a fine equivalent to the cost of installing a small swimming pool.  Leaving your lawn or your shrubs uncut for two months could cost you the price of a really nice swimming pool  – or a great European vacation.

The statute requires that such owners “maintain” the exterior of their vacant properties.  The new law doesn’t given a detailed description of the maintenance that must be performed, but the law does state that “failure to maintain” includes a failure to trim excess “foliage” that diminishes the value of neighboring properties.  “Failure to maintain” also includes failure to keep trespassers or “squatters” off the property.  And the owner will also be in violation if there’s standing water that results in mosquito breeding.

Pirate Ship Sails On

            Several years ago, we visited the Paramount Theater in Oakland, California where I saw for the first time “The Black Pirate” starring Douglas Fairbanks.  The film was released in 1926. It was a “silent” movie that had been filmed in black and white.  While we watched the film, “The Mighty Wurlitzer” organ was played by a superbly talented organist. The “Wurlitzer” supplied all of the music that was necessary to accentuate the drama, excitement, and emotion that accompanied the film.

The film is about a young man who swears to avenge his father’s death against the band of pirates who were responsible.  Douglas Fairbanks infiltrates the pirate band, and eventually makes good on his promise of revenge.

After the movie was over, I called my own father to give him a report of the movie.  I thought that we had discovered something new with this movie.  After I said that we had just finished watching “The Black Pirate,” my father took me completely by surprise by describing in glowing terms a dramatic scene where Douglas Fairbanks leaps from the mast of the ship, plunges a knife into the sail, and slides completely down the sail to the deck, using the drag from the tearing mast to slow his descent.

I never knew my father to go back and watch old movies.  My father was born in 1918 and The Black Pirate was released when he was only 8 years old.  This meant that my father probably remembered this thrilling scene from his own boyhood, when as an impressionable 8 year old he saw The Black Pirate in a theater at the time it was first released.  He had remembered that scene for some 70 years, and recounted it to me after I told him we had seen the film.

Eight year old boys are impressionable.  No doubt about it.

News reports in recent years have shown that piracy has been a continuing problem in some parts of the world.  But it’s unlikely that most people are likely to ever have much interaction with piracy – unless they happen to run across the “BLACK PRINCE” (which “BLACK PRINCE” has no connection with the “Black Pirate” movie described above).

It seems that a company in Maine owned a vessel known as the “BLACK PRINCE.” It was “designed to resemble a pirate ship and to carry passengers on pirate-themed excursions.”  This company in Maine leased the BLACK PRINCE to a separate company that was headquartered in Florida.

The Florida company had the BLACK PRINCE transported to Florida via truck (it makes you wonder why they just didn’t sail the ship from Maine to Florida under its own power.  Perhaps pirate ships aren’t well-received these days along the eastern seaboard).  After the ship arrived in Florida, the United States Coast Guard performed an inspection, and found that the ship was powered by an outboard engine supplied by gas fuel tanks.  The Coast Goard issued a certificate of inspection that prevented the use of “open flames” aboard the BLACK PRINCE.

When it was sailing in Maine, the BLACK PRINCE periodically fired a “yacht signal cannon” as part of its “pirate theme excursions.”  However, the written lease didn’t say anything about a “cannon.”

The Florida company apparently wanted to use an onboard cannon as part of the “pirate” experience.  But the BLACK PRINCE was shipped from Maine to Florida without the cannon, so the Florida company ended up purchasing its own “Standard Black Winchester Cannon.”  (Incidentally, these “Standard Black Winchester Cannons” are apparently still available online).  The Florida company only paid 2 and a half months of lease payments and then discontinued making any further lease payments.

The Maine company repossessed the ship and sued the Florida company for breach of the lease agreement.  In its defense, the Florida company claimed that the Maine company breached the lease because it agreed to provide a pirate ship that could use a cannon, and the Coast Guard’s inspection certificate prevented any open flame aboard the ship.

The matter proceeded to trial, and the court found no evidence that the coast guard certificate prevented use of the cannon.  The court further found that even if the Maine company “breached” the lease agreement, that such “breach” wasn’t “material” and so the Florida company was left without excuse for not making its lease payments.

The end result?  The Maine company who owned the ship received a judgment against the Florida company for $67,386.79 for breach of the pirate ship lease.

So what was the cost to lease a pirate ship?  In this case, it was $3,700 per month, plus 5% of the gross sales.  The case is reported as Culebra II, LLC v. River Cruises and Anticipation Yachts, LLC (2008) 564 F. Supp. 2d 70.

Pre-Payment Penalties Are Often Allowable

            Money Lending has been around for thousands of years.  And regulation of money lending has also been around for thousands of years.  Some of the oldest known regulations for money lending are found in the earliest parts of the Bible at the Book of Exodus, where certain restrictions are made against charging interest on loans of money.  But in today’s world, loans are bought and sold like many other commodities.  It’s therefore not surprising that many laws and regulations have been passed concerning the lending and borrowing of money.

One regulation about money lending that may be unknown to some people is the lender’s ability to charge a penalty for early repayment of a loan.  At first glance, this may seem like an odd thing.  Lenders generally make loans with an expectation that the loan amount will eventually be repaid with interest.  If a borrower is able to repay a loan early, it could seem like a lender might be very interested in accepting a borrower’s early payments.

But a key aspect of money lending is time.  Interest is generally computed based on the passage of time.  If a lender makes a loan and the borrower repays early, then the lender may lose the interest that would have accrued on the loan.  In addition, tax considerations are often based on time as well.  Repayment of a loan with interest in any given year may create a markedly different tax result for the lender than repayment in a later year.

All of these considerations can play a part in a lender’s decision to include a “prepayment penalty” with a loan.  A “prepayment penalty” provision generally provides that if a borrower repays a loan early, then the borrower will pay a “penalty” for making the early payment.  Such “penalty” is generally in addition to all of the interests, fees, points and other charges that the borrower would have already paid in connection with such loan.

This kind of arrangement can seem burdensome to borrowers.  After all, many borrowers only seek loans because they don’t have the necessary cash to buy a home, a lot, or some other goods.  The borrower already has paid or will pay the lender fees and interest – adding a prepayment penalty can add to the financial burden already being experienced by a borrower.

But California law allows lenders to charge prepayment penalties. For example, it’s possible for a lender to absolutely prohibit early repayment of a loan.  One California court has noted that “in the absence of a statute a debtor has no more right to pay off the obligation prior to its maturity date than he does to pay it off after its maturity date.”  Williams v. Fassler (1980) 110 Cal. App. 3d 7, 10.  In the alternative, many lenders can charge a “fee” or a premium in exchange for agreeing to accept early payment.

Pre-Payment Penalty Provisions Can Be Significant

A “pre-payment penalty” is a penalty, or a charge, assessed against a borrower by a lender for the privilege of paying off a loan early.  Unless a lender agrees or unless a statute applies, lenders in California aren’t obligated to accept early payoff on a loan. Instead, in some cases a lender can charge a penalty to a borrower who wants to pay their loan off early.  Such a penalty is commonly known as a “pre-payment penalty.”

California law provides a number of protections for borrowers who have loans secured by residential properties.  This is especially true where a borrower actually lives in the property.  For example, if a single family residential home is occupied by the borrower, then the law provides that most such borrowers can prepay their loan balance at any time, regardless of what the loan documents provide. In most cases the lender on such a loan will be absolutely barred from refusing to accept an early loan payoff.  Such an early loan payoff can be very important to a borrower who wants to refinance, or who needs to move and who wants to pay off their loan early.  However, most lenders on residential loans can still charge a pre-payment penalty if the borrower pays a loan off early.  The amount of the penalty and the borrower’s ability to pay off early depends on several things, such as the terms of the loan documents, whether the borrower actually lives in the property, and whether or not the loan was negotiated by a real estate broker.

If a borrower is an owner-occupant of a single family residential property, then in most cases that borrower will be able to pre-pay up to 20 percent of the loan balance in any given 12 month period.  The law provides that in most cases this pre-payment can be made without penalty, regardless of what the loan documents say about pre-payment penalties.  In these cases, the borrower can also pre-pay more than 20% of the loan balance, but if the borrower pre-pays more than 20% in any given 12 month period, then the lender can charge a penalty that is not more than six months’ worth of interest payments.  In such a situation, the borrower still gets to pay 20% of the loan balance without penalty, and only the prepaid amount over 20% is subject to the six months of interest penalty.  After five years, the lender isn’t entitled to receive any pre-payment penalty at all, even if the borrower pays off more than 20% of the loan balance in any given year.

Different rules apply if the loan was negotiated by a real estate broker or if the borrower doesn’t live in the property.  Different rules also apply if the property consists of five or more dwelling units.  And if a borrower pre-pays a loan after the California Governor has declared a state of emergency, then in some cases it’s possible that no pre-payment penalty may be due at all.

Most of the pre-payment penalty protections that apply to residential property don’t apply to commercial or industrial property.  As a result, pre-payment penalties on commercial or industrial loans can be surprisingly high.

 

After litigating for more than 30 years, Robert Jacobs now mediates challenging real estate, business, construction, personal injury, trust and probate cases. In 2020 he served as Chair of the Contra Costa County Bar Association ADR section and Co-Chair of the Alameda County Bar Association ADR section.  Since 2017 he has served as one of the update authors for the CEB treatise Real Property Remedies and Damages and is a co-author of CEB Practitioner (Real Property). He holds an AV rating from Martindale-Hubbell and is a designated SuperLawyer. Mr. Jacobs received his mediator training from Northwestern University in Chicago, Illinois.

Pre-Payment Penalty Rates Can Be High

The last two articles discussed pre-payment penalties in loan transactions.  A “pre-payment penalty” is a penalty, or a charge, assessed against a borrower by a lender for the privilege of paying off a loan early.  Unless a lender agrees or unless a statute applies, lenders in California aren’t obligated to accept early payoff on a loan. Instead, in some cases a lender can charge a penalty to a borrower who wants to pay their loan off early.  Such a penalty is commonly known as a “pre-payment penalty.”

The effect of a pre-payment penalty loan provision can be significant. In one case, a borrower purchased a small ranch on 20 acres of land.  The Seller agreed to finance the sale by taking back a promissory note from the buyer.  The contract provided that the Buyer would only make limited payments to the Seller during the first five years after the sale.  The Seller wanted to stretch the payments out over several years because the Seller’s tax payments would be considerably smaller than if the purchase price were all paid at once.  The loan documents   provided that if the Buyer paid off the loan early, then the Buyer would pay the Seller a significant pre-payment penalty.

Several months after buying the ranch, the Buyers filed suit against the Seller and sought to invalidate the pre-payment penalty portion of the loan documents.  The Buyers wanted to build a new home on the ranch, and they needed to pay off the loan from the Seller in order to get a new loan to finance the construction of their new home.

The Buyers claimed that the pre-payment penalty was so high that it was unreasonable.  The Seller demonstrated to the court that if the Buyer paid the loan off early, the Seller would suffer severe negative tax consequences.

The Court reviewed the applicable law, and noted that several code sections provide Borrowers with pre-payment penalty protections for residential property.  But apparently because this property was primarily a ranch instead of a residence, the court didn’t apply the protections available to residential homeowners.  Instead, the Court upheld the pre-payment penalty amount provided in the loan documents.

The amount of the pre-payment penalty?  Fifty percent.  This means that the lender could legally charge and collect from the Borrower a penalty of fifty percent on all prepaid amounts as provided by the loan documents.

A fifty percent increase in the amount needed to payoff a loan is significant.  A fifty percent penalty on early loan payment would usually seriously alter the attractiveness of a loan. Not all pre-payment penalty rates are as high as fifty percent.  But in the appropriate circumstance, a pre-payment penalty of even fifty percent can be legal.

Pre-payment penalties, like many loan terms, are complex and are governed by several different statutes. Loan terms and documents can be complex and may be unfavorable or misleading.  Persons interested in signing loan documents and borrowing money do well when they consult competent legal counsel.