A recent California case warns that interest may not be collectible at a default rate following loan maturity if the loan documents are not properly drafted.  The case of JCC Development Corp. v. Hyman Levy, decided by a California appellate court at the end of August 2012, involved a borrower's claim to recover default interest paid to a private lender.  When the loan was not repaid at maturity, the lender began foreclosure proceedings and demanded interest at the default rate from the maturity date.  The borrower paid the full amount demanded under protest, and then sued the lender to recover the difference between the note rate and the default interest rate.

The promissory note provided for a default interest rate that was higher than the note rate, but tied the default interest to an acceleration provision (stating that the lender could call amounts due under the loan “immediately due and payable” following a default).  The court reasoned that because the note had matured there could have been no acceleration, as the loan already was due and payable at the time of the default.  As a result, the court held that the default interest rate was never triggered, and that the lender must return the excess interest to the borrower.

The promissory note in this case was poorly-worded, and most notes we have seen do not have the same weakness. Nevertheless, the case provides a warning to lenders that loan documents need to be well-prepared in order to safeguard the benefits lenders believe they are getting from them.