## Facts

- River East Plaza, LLC, a commercial real-estate developer, sought financing to buy out a co-owner’s interest in a Chicago property for about $12 million.
- Variable Annuity Life Insurance Company (VALIC) agreed to lend on terms River East wanted regarding closing timing and interest rate, but insisted on a yield-maintenance prepayment clause.
- River East negotiated to remove the yield-maintenance term; VALIC refused, and River East proceeded with counsel.
- The loan included a prepayment fee designed to preserve VALIC’s expected yield by measuring the difference between the contract interest stream and the return available by reinvesting prepaid principal at then-current U.S. Treasury yields through the loan’s maturity.
- Years later, River East sold the property and prepaid the loan, avoiding roughly $13 million in future interest payments.
- River East paid the yield-maintenance charge under protest and sued to recover it, asserting the clause was an unenforceable penalty under Illinois law.

## Issues

1. Whether the yield-maintenance prepayment clause in a negotiated commercial loan is an unenforceable penalty under Illinois contract law or an enforceable liquidated-damages/pricing term.
2. If enforceable, whether the lender miscalculated or overcharged the prepayment fee so as to warrant relief.

## Decision

- The Seventh Circuit reversed the district court’s judgment for River East and remanded.
- The court held the yield-maintenance clause was not an unenforceable penalty under Illinois law.
- The court concluded the district court misapplied the reasonableness analysis and did not correctly determine any overcharge.
- On remand, the district court was directed to address whether VALIC was the prevailing party for contractual attorneys’ fees and costs.

## Legal Principles

- Under Illinois law, a contractual charge is unenforceable as a penalty when it is unreasonably large in relation to anticipated loss or is structured mainly to coerce performance rather than compensate for harm.
- In sophisticated, counsel-represented commercial lending, clearly stated prepayment premiums are generally enforceable when they reasonably approximate the lender’s expected loss from early repayment.
- A yield-maintenance clause that ties the charge to prevailing interest rates and reinvestment returns functions as a risk-allocation/pricing term for fixed-rate credit, not a punitive exaction.
- A borrower’s ability to prepay a fixed-rate loan may be treated as a paid-for contractual option; enforcing the agreed price for that option does not itself make the charge a penalty.

## Conclusion

The Seventh Circuit enforced a negotiated yield-maintenance prepayment clause as consistent with Illinois law on liquidated damages and commercial risk allocation, and it reversed a ruling that treated the charge as a penalty and as an overcharge, remanding for further proceedings including potential fee-shifting issues.


River East Plaza, LLC v. Variable Annuity Life Ins. Co., 498 F.3d 718 (7th Cir. 2007)