October 12, 2001

On September 25, 2001, the United States Ninth Circuit Court of Appeals held that a lender was not entitled to default interest where the lender failed to send the borrower an acceleration notice--even though the loan documents did not require such a notice. Beal Bank v. Crystal Properties (In re Crystal Properties).

BACKGROUND
Promissory notes in a series of loans to the same borrower provided that, upon default, “at the option” of the lender, “without notice or demand”, the entire loan balance would immediately become due and that, upon such acceleration, a default interest rate would apply. There were a number of defaults under the notes, including the failure to repay upon maturity as to some loans. The district court found that default interest did not apply because the lender failed to take any affirmative action to exercise the option to accelerate. Moreover, default interest did not apply to matured loans because the default interest clause in the notes was tied to the option to accelerate (i.e., the notes provided that default interest commenced from acceleration and did not state that default interest applied from maturity).

THE DECISION
In interpreting California law, the Ninth Circuit agreed with the lower court that the loans could not be accelerated unless the lender gave the borrower a “clear and unequivocal” notice of acceleration. Even though the notes stated that acceleration was allowed “without demand or notice”, the court imposed a notice requirement. Because the notes, by their terms, provided that default interest applied only after acceleration, default interest failed to apply. The Court indicated that, if the notes had provided that default interest began to accrue from the default (rather than from acceleration), it would have allowed default interest (although the enforceability of such default interest may not be as certain as the Court seemed to believe).
With respect to the matured loans, the Ninth Circuit also agreed that the lender was not entitled to default interest. It construed the notes as providing for default interest only upon acceleration, and the maturity was not an acceleration. Again, the Court indicated that if the notes had provided that default interest also accrued from maturity (rather than just from acceleration), it would have allowed default interest.

SIGNIFICANCE OF CASE
Although the decision does not necessarily bind California courts, there are several important lessons.

· Acceleration Notice. Even if loan documents allow acceleration without notice to the borrower, lenders should send acceleration notices; otherwise, acceleration may not occur and the default interest, if tied to acceleration, may not apply.

· Maturity. Lenders must ensure that their loan documents require default interest to apply not just on acceleration, but also specifically from maturity of the loan.

· Documentary Notice Requirements. Lenders could provide that default interest commences from the date of default rather than from acceleration (although it is not entirely clear whether such interest would be viewed as an unenforceable penalty under California law). Similarly, lenders could provide for automatic acceleration on default (although this approach could have unintended consequences, including causing loans to be classified as nonperforming and subjecting lenders to possible waiver claims if no immediate action is taken by the lender).
If you have any questions concerning this case or would like a copy of the referenced decision, please feel free to call any of the following members of our financing group: