STATE OF MICHIGAN

FRANK J. KELLEY, ATTORNEY GENERAL

Opinion No. 6537

September 13, 1988

BANKS AND BANKING:

Collection of a commitment fee and imposition of liquidated damages for breach of a contract for a residential mortgage

If a bank and borrower enter into a bilateral contract for a residential mortgage, the bank may neither collect a commitment fee nor impose a liquidated damages provision upon the borrower for failure to complete the transaction, but the bank may recover actual damages incurred for breach of the contract by the borrower.

Honorable John D. Pridnia

State Representative

The Capitol

Lansing, Michigan 48909

You have requested my opinion on a question which may be stated as follows:

Your opinion request presupposes that in connection with a proposed loan to be secured by a lien on residential real property, the bank sends a letter to the borrower prior to closing, the purpose of which is not only to bind the bank to lend the money in exchange for a "commitment fee," but also to bind the borrower to complete the transaction. If the borrower fails to complete the transaction by actually borrowing the money, the borrower is, by the terms of the letter, liable for a specified amount of liquidated damages.

The background material included with your opinion request states that the Federal Truth in Lending Act, 15 USC 1601 et seq, creates a three day right of rescission in most non-purchase money loans involving a security interest in the borrower's principal residence. The borrower has three days in which to rescind the transaction, running from the date the loan is "consummated," or the date certain required disclosures are made, whichever is later. 15 USC 1635. Apparently some lenders find this rescission period inconvenient. If the loan is not consummated until closing, the lender will not advance the funds until the three day period expires. Borrowers must wait an additional three days, therefore, in order to actually get use of the borrowed funds. Lenders are charging interest on the funds during this three day period even though the funds are not available to the borrower until after the period runs.

In order to avoid these perceived problems, some lenders would like to "consummate" the loan--and thereby begin the running of the rescission period--more than three days prior to closing. The rescission period would expire, therefore, before closing and the lender would then be free to release the funds at closing. Under federal law, a loan is "consummated" when the borrower "becomes contractually obligated on a credit transaction." 12 CFR 226.2(a)-13. According to background material submitted with your request, it is for this reason that lenders want to obligate contractually borrowers at least three days in advance of closing to accept the loan or pay liquidated damages. The lenders wish to continue to collect a commitment fee as well.

MCL 438.31a; MSA 19.15(1a), provides in relevant part as follows:

Thus, banks are limited to reasonable and necessary charges "which are the actual expenses incurred by the lender." Liquidated damages may be employed, however, only where actual damages for a breach of the contract "are uncertain in their nature, difficult to be ascertained, or impossible to be estimated with certainty, by reference to any pecuniary standard." Jaquith v. Hudson, 5 Mich 123, 137 (1858). Since the expenses incurred by a bank are readily ascertainable, a bank may not resort to a liquidated damages provision for such expenses. Damages in the nature of loss of profit caused by loaning the monies at a lower rate of interest, for example, are readily ascertainable at the time breach occurs and, therefore, they cannot form the basis for a liquidated damages clause. Also, a bank which has already collected fees for credit reports, appraisals, deed preparation and for processing the loan application which reflect its actual expenses in connection with the loan, may well have no additional expenses if the loan is not completed.

Further, in the case you present, the bank is not permitted to charge a "commitment fee." The commitment fee is "consideration received by a lender in return for its promise to make a loan at some future date at a specific rate." OAG, 1981-1982, No 5972, p 350, 354 (September 2, 1981). It binds the lender, but not the borrower, and hence is in the nature of an option purchased by the borrower. The bank is obligated to complete the loan, but the borrower is free to decline to borrow the money if, for example, the borrower can borrow the money at a lower rate of interest elsewhere. The lender provides something of value separate from the loan itself in exchange for the commitment fee.

Your opinion request presupposes a very different situation in that instead of a unilateral commitment by the bank, a bilateral commitment binding the borrower also is contemplated. At the time of the "commitment" the borrower would be bound to complete the loan transaction or pay damages. The borrower would no longer have the option of declining to borrow the money. The bank would be assuming no greater obligation, however, than that which it undertakes at closing, i.e. to loan the money at a given rate of interest. There would not be an additional consideration--the unilateral option--to justify the separate commitment fee. MCL 438.31a; MSA 19.15(1a), forbids a bank from imposing charges for which it renders no services. OAG, 1981-1982, No 5895, p 170, 172-173 (May 11, 1981). Thus, where the bank intends to bind the borrower in advance of closing, it cannot impose either a commitment fee or liquidated damages and is limited to its actual expenses resulting from the borrower's failure to complete the loan.

The preemption provisions of the Depository Institutions Deregulation and Monetary Control Act of 1980 (DIDMCA) do not affect this conclusion. In that Act, Congress preempted state usury laws applicable to loans secured by first liens on residential real property in some circumstances. Your request, although not limited to first liens, would encompass first liens as well as subordinate liens. The relevant language provides:

The reason for the federal preemption has been explained as follows:

Furthermore, the Federal Home Loan Bank Board has adopted the following regulations interpreting the preemption section:

Thus, DIDMCA preempts state laws setting limits on the cost of money for loans secured by first liens on residential real property. The limitations in MCL 438.31a; MSA 19.15(1a), however, do not deal with the cost of money borrowed, but, rather, with other charges made by the lender. MCL 438.31a; MSA 19.15(1a), does not limit interest rates and, therefore, it does not limit the availability of loan money. It protects borrowers from unjustified charges disguised as "fees."

It is my opinion, therefore, that if a bank and borrower enter into a bilateral contract for a residential mortgage, the bank may neither collect a commitment fee nor impose a liquidated damages provision upon the borrower for failure to complete the transaction, but the bank may recover actual damages incurred for breach of the contract by the borrower.

Frank J. Kelley

Attorney General