Commercial Loan Prepayment Penalties and Demand Clauses

Yes, we believe you may charge prepayment penalties on all types of commercial loans. Regulation Z and the Illinois High Risk Home Loan Act impose restrictions on prepayment penalties for certain consumer loans, but these restrictions do not apply to commercial transactions.

Similarly, we believe that you may add demand features to your commercial loan contracts in Illinois. Regulation Z prohibits the use of demand features in high-cost mortgage loans and home equity lines of credit, but these prohibitions do not apply to commercial transactions. However, note that at least one court in Illinois has called into question whether a demand feature is enforceable — the court found that a loan note with a demand clause was ambiguous because the note also included acceleration clauses that gave the bank the right to accelerate the loan on specified events of default. Additionally, in the consumer context, a borrower has challenged a bank’s exercise of a demand feature in a consumer line of credit as “deceptive” because the loan was structured as a term loan. However, the court ultimately rejected the borrower’s claim and found that the demand feature, alone, was not deceptive.

Interest Rate Limits and Prohibited Collateral

There are very few limitations on interest rates charged by banks under Illinois law, provided the rates are agreed to by your customers. The Illinois Banking Act permits banks to charge any “interest, fees, and other charges . . . subject only to the provisions of [subsection 4(1)] of the Interest Act” and any laws applicable to “credit secured by residential real estate.” This provision applies to banks “notwithstanding the provisions of any other law.” Subsection 4(1) of the Interest Act permits banks to collect interest at any rate agreed upon by a bank and its borrower and specifies that it is lawful to charge, contract for, and receive any rate or amount of interest for any loan made to a corporation and loans secured by a mortgage on real estate (with the exception of transactions covered by the Predatory Loan Prevention Act, which does not apply to banks).

Also, we are not aware of any law or regulation expressly prohibiting the use of certain types of collateral to secure a commercial loan.   

For resources related to our guidance, please see:

• Regulation Z, 12 CFR 1026.43(g) (“(1) A covered transaction must not include a prepayment penalty unless: (i) The prepayment penalty is otherwise permitted by law; and (ii) The transaction: (A) Has an annual percentage rate that cannot increase after consummation; (B) Is a qualified mortgage . . . ; and (C) Is not a higher-priced mortgage loan, as defined in § 1026.35.”)

• Regulation Z, 12 CFR 1026.43(a) (“This section applies to any consumer credit transaction that is secured by a dwelling, as defined in § 1026.2(a)(19), including any real property attached to a dwelling, other than: . . .”)

• Regulation Z, 12 CFR 1026.32(d) (“A high-cost mortgage shall not include the following terms: . . . (6) A prepayment penalty, as defined in paragraph (b)(6) of this section.”)

• Regulation Z, 12 CFR 1026.32(a)(1) (“The requirements of this section apply to a high-cost mortgage, which is any consumer credit transaction that is secured by the consumer’s principal dwelling, other than as provided in paragraph (a)(2) of this section, and in which: . . .”)

• Illinois High Risk Home Loan Act, 815 ILCS 137/30 (“A high risk home loan may not contain terms under which a consumer must pay a prepayment penalty for paying all or part of the principal before the date on which the principal is due. . . .”)

• Illinois High Risk Home Loan Act, 815 ILCS 137/10 (“‘High risk home loan’ means a consumer credit transaction, other than a reverse mortgage, that is secured by the consumer’s principal dwelling if: . . .”)

• Regulation Z, 12 CFR 1026.32(d) (“A high-cost mortgage shall not include the following terms: . . . (8) Acceleration of debt. A demand feature that permits the creditor to accelerate the indebtedness by terminating the high-cost mortgage in advance of the original maturity date and to demand repayment of the entire outstanding balance, except in the following circumstances: . . .”)

• Regulation Z, 12 CFR 1026.40(f) (“Limitations on home equity plans. No creditor may, by contract or otherwise: . . . (2) Terminate a plan and demand repayment of the entire outstanding balance in advance of the original term (except for reverse mortgage transactions that are subject to paragraph (f)(4) of this section) unless: . . .”)

• Regulation Z, 12 CFR 1026.40 (“The requirements of this section apply to open-end credit plans secured by the consumer’s dwelling.”)

• N.W.I. Int’l, Inc. v. Edgewood Bank, 291 Ill.App.3d 247, 256–57 (1st Dist. 1997) (“Examination of the consolidated note reveals that the words, ‘on demand’ are prominent and typewritten in two places and included again in the note’s form language. However, the note also includes three instances of form language, in what is best described as ‘fine print,’ mentioning terms of default that would trigger the bank’s right to accelerate payment. In addition, other events of default are recited in the September 1980 security agreement which has been specifically incorporated by reference. . . . Accordingly, since the note appears to be ambiguous, the issue as to whether the parties intended that the instrument be a demand note must be submitted to the jury.”)

• Nilsson v. NBD Bank of Illinois, 313 Ill.App.3d 751, 764–65 (1st Dist. 1999) (The borrower “offered evidence that the deceptive act committed by the bank and its loan officers was the insertion of a demand feature into the promissory note [and] further asserted that the ‘deception’ continued when defendants sought to enforce the demand feature of the note notwithstanding the true intent of the parties to execute a term loan rather than a demand loan. . . . After reviewing the evidence, we agree with the trial court that [the borrower’s] claim for damages as a result of the bank’s alleged violation of the Act failed because the evidence offered at trial did not show that the bank’s actions amounted to an act of deception.”)

• Illinois Banking Act, 205 ILCS 5/5e(a) (“Notwithstanding the provisions of any other law in connection with extensions of credit, a State bank may elect to contract for and receive interest, fees, and other charges for extensions of credit subject only to the provisions of subsection (1) of Section 4 of the Interest Act, except for extensions of credit secured by residential real estate, which shall be subject to the laws applicable thereto.”)

• Illinois Banking Act, 205 ILCS 5/5e(b) (“The establishment of account service charges and the amounts of the charges not otherwise limited or prescribed by law is a business decision to be made by a bank according to prudent business judgment and safe and sound operating standards. In establishing account service charges, the bank may consider, but is not limited to considering, the costs incurred by the bank, plus a profit margin, for providing the service, the deterrence of misuse of the bank’s services, the establishment of the competitive position of the bank in accordance with the bank’s marketing strategy, and the maintenance of the safety and soundness of the bank.”)

• Interest Act, 815 ILCS 205/4(1) (“It is lawful for a state bank or a branch of an out-of-state bank . . . to receive or to contract to receive and collect interest and charges at any rate or rates agreed upon by the bank or branch and the borrower. . . .”)

• Interest Act, 815 ILCS 205/4(1) (“It is lawful to charge, contract for, and receive any rate or amount of interest or compensation, except as otherwise provided in the Predatory Loan Prevention Act, with respect to the following transactions: (a) Any loan made to a corporation; . . . (l) Loans secured by a mortgage on real estate . . .”)

• Predatory Loan Prevention Act, 815 ILCS 123/15-1-15(c) (“Banks, savings banks, savings and loan associations, credit unions, and insurance companies organized, chartered, or holding a certificate of authority to do business under the laws of this State or any other state or under the laws of the United States are exempt from the provisions of this Act.”)