CHAPTER 4.05. Interest and Late Charges

• Jurisdiction: United States

4.05. Interest and Late Charges

[1] Interest

A Delaware bank, Delaware trust company, depository institution organized under federal law and having its principal place of business in Delaware, or lender licensed under Delaware's licensed lender laws may charge and collect periodic interest, whether under a revolving credit plan or for a loan, at whatever periodic percentage rate and manner of payment is provided for in the written agreement governing such revolving credit plan or loan.²¹ The periodic percentage rate or rates of interest under the revolving credit plan or loan may vary from time to time in accordance with a schedule or formula and may be made applicable to all or part of the outstanding unpaid indebtedness, provided the terms are set forth in the written agreement governing such revolving credit plan or loan.²²

[2] Usury

Usury in Delaware means the direct or indirect payment by a borrower to a lender of interest at a rate higher than permitted by Delaware law.²³ Delaware law provides only limited restrictions on interest rates. There is no limitation on the rate of interest that may legally be charged if any one of the following applies: (i) the borrower is a corporation, limited partnership, statutory trust, or limited liability company;²⁴ (ii) the borrower is an association or joint stock company having any of the powers and privileges of corporations not possessed by individuals or partnerships;²⁵ or (iii) the amount of the loan exceeds $100,000 and repayment is not secured by a mortgage against the principal residence of the borrower.²⁶ These same exceptions apply to guarantors. For example, because a Delaware corporate borrower is statutorily prevented from asserting the defense of usury, an individual who has guarantied the obligations of the corporate borrower is also prevented from asserting the defense of usury.²⁷ What is not so clear is whether a court outside Delaware would necessarily recognize these procedural defenses.²⁸ Because of the broad exceptions to the occurrence of usury under Delaware law, the potential challenges to enforcement of these procedural defenses outside Delaware are less meaningful. However, one should be aware of such line of reasoning.

Likewise, one should be aware of the cases that have held as unenforceable those savings clauses that purport to avoid the consequences of usury. Most loan agreements and promissory notes contain a clause that attempts to avoid the effect of interest payments being found to be usurious, typically by recharacterizing the interest payments as a principal payment. Unfortunately, courts in a number of important commercial jurisdictions, including New York, New Jersey, Texas, Florida, and California, have held these savings clauses to be unenforceable, generally on the basis that the lender's intent or other reason for the usurious interest rate is irrelevant. If the loan is usurious, it cannot be remade to be otherwise.²⁹

Delaware's limited usury restrictions do not apply to loans made by Delaware banks, trust companies, depository institutions organized under federal law and having their principal place of business in Delaware, or lenders licensed under Delaware's licensed lender laws and regulations. On the other hand, Delaware's usury restrictions apply to loans by non-Delaware banking corporations that are not located in the State of Delaware but lend in the State of Delaware with respect to secured demand loans for less than $5,000.³⁰

For the few commercial situations where Delaware's usury restrictions are applicable, the lender may charge interest at any rate agreed upon in writing not in excess of 5 percent over the Federal Reserve discount rate (including any surcharge).³¹ In the event the rate of interest charged by the lender exceeds the lawful rate, the borrower is not required to pay the excess and can retain and deduct the excess from the amount of any debt.³² If the entire debt is paid with interest exceeding the lawful rate and the borrower brings an action to recover within one year of payment, the borrower may recover the greater of $500 or three times the amount of the excess interest.³³

[3] Prepayment

Absent a right under contract or statute, a debtor has no right to pay an obligation before it comes due.³⁴ Put differently, the lender has no obligation to accept a prepayment of the debt, even in its entirety, before the due date. This follows from considering the debt, and the lender's rights to recover the debt, as comprising both the principal of the obligation and the interest and other terms of repayment. In other words, it is not enough for me to receive back the principal I lent you; I am entitled to the interest that would have accrued over the term of the loan. Forcing me to accept a prepayment prevents me from recovering the entirety of that investment. For this reason, lenders might expressly prohibit prepayment or charge a fee or premium should the debtor wish to prepay or if some other event occurs that triggers an involuntary prepayment, such as by way of insurance proceeds paid to the lender after a casualty.

Under Delaware law, a lender may charge a prepayment fee on prepayment of loans made by that lender.³⁵ The degree to which this can be done, however, depends principally on several factors. First, Delaware statutes regulate the ability to charge such a fee based on certain considerations, including the legal status, or type, of lender, the identity of the borrower, type of loan, and the nature of the collateral, if any. In addition, various issues arising under bankruptcy law and common law are relevant.

First, Delaware statutory requirements must be met, most of which relate to the type of lender. Generally, there are three types of lenders to consider (not including a private party who might make a loan to another person as a one-off occurrence). The lender might be a licensed lender regulated by Delaware law; the lender might be a bank regulated by Delaware law; or the lender might be an entity that is not a bank and is exempt from the requirement to be licensed as a licensed lender, such as an insurance company, a federal credit union, or a lender organized under federal law.³⁶

[a] Licensed Lender

The Licensed Lender Act³⁷ provides that a borrower may prepay a loan in full at any time.³⁸ Licensed lenders may precompute and take an advance payment of interest on a loan, but the unearned portion of the precomputed interest charge must be refunded using the actuarial method in the event of a prepayment in full, as long as the refund is at least $5.00.³⁹ Similar principles apply to the refunding of unused portions of insurance premiums that are paid by a borrower to a licensed lender.⁴⁰

Licensed lenders may not impose any prepayment charge on an individual borrower (meaning a natural person) who prepays any loan that is not a residential mortgage loan.⁴¹ For a residential mortgage loan to an individual borrower, however, a licensed lender may charge and collect any prepayment fee that is specified in the agreement governing the loan.⁴² As the Act is otherwise silent, presumably a licensed lender could impose a prepayment charge on any borrower who is not a natural person, so long as the agreement governing the loan specifies that such a fee may be imposed. By analogy to the requirements for a bank discussed below, it may be advisable to have such a charge specified in the loan agreement or other document evidencing the loan.

[b] Delaware Bank⁴³

The statutes governing revolving credit or similar open-ended credit by a Delaware bank provide that if the borrower is a natural person, the borrower may prepay the loan at any time, and the bank may not impose a prepayment charge.⁴⁴ The only exception is that the bank may charge a fee to terminate the loan if the agreement governing the loan allows for that charge.⁴⁵ If the loan is secured by a mortgage on real property, even if the borrower is an individual, the bank may charge a prepayment fee.⁴⁶ If the borrower is not a natural person, and regardless of the nature of any collateral securing the loan, the bank may charge a prepayment fee if the bank and borrower agree.⁴⁷

Similarly, the statutes governing a closed-end credit provide that if the borrower is a natural person, the borrower may prepay the loan at any time.⁴⁸ If the loan is secured by a mortgage on real property, however, even if the borrower is a natural person, the bank may charge a prepayment fee so long as it is specified in the agreement, note, or other evidence of the loan.⁴⁹ As with a licensed lender, the bank may charge precomputed advance interest, but must refund the unearned portion in the event of prepayment.⁵⁰ Likewise, provisions comparable to those for a licensed lender apply to prepaid insurance premiums.⁵¹ If the borrower is not a natural person, and regardless of the nature of any collateral securing the loan, the bank may charge a prepayment fee if the bank and borrower agree.⁵²

[c] Lender Not Regulated by Delaware

Except as provided for a licensed lender or a bank, there are no Delaware statutory limitations on charging a fee or premium for prepayment of a loan. But as with a prepayment fee charged by a licensed lender or a bank, a prepayment fee charged by a lender not regulated as a licensed lender or a bank could be found through legal proceedings to be a penalty and therefore unenforceable. However, federal savings associations may include and enforce prepayment premium provisions in loan documents for loans regardless of state law, including equitable principles.⁵³

[d] Bankruptcy and Common Law

The cases addressing the enforcement of a prepayment fee are all over the map, and unfortunately, there has been no Delaware case addressing the issue.⁵⁴ Generally, the cases fall into a few general themes. First, the consideration of the enforceability of a prepayment in a bankruptcy situation differs from consideration outside bankruptcy. Second, courts are more likely...