What should a bank or credit union do when a borrower tries to make a monthly payment on a loan in default? Does that answer change when a borrower has more than one loan? And can a lender keep a partial payment made on a loan in default without jeopardizing liquidation? Ohio’s banks and credit unions face these questions in almost every loan before they file a lawsuit.
In Ohio, loan documents govern how lenders must accept and apply payments.[1] Even so, few documents consider how to handle partial payments made after default or maturity. In fact, in our experience, few, if any, stock loan documents govern accepting and applying payments after default when a borrower owes multiple loans. In those cases, Ohio case law that is nearly 150 years old governs.
First and perhaps most importantly, lenders have no obligation to accept a post-default or post-maturity payment unless the loan documents require it.[2] But where a lender accepts a partial payment from a debtor who owes multiple debts, the debtor has the right to choose which debt he or she will pay first.[3] The Ohio Supreme Court gave debtors that right in 1876 when it ruled that where “a person owes another several distinct debts, he has the right to choose which debt he will pay first; and where, at the time of payment, he expressly directs what application is to be made of the payment, the creditor, if he retains the money, is bound to appropriate it as directed by the debtor.”[4] With those rules in mind, how should a lender handle a post-default or post-maturity payment?
Unless loan documents state otherwise, a lender may accept payments on loans in default without waiving those defaults.[5] Yet in an ensuing lawsuit, most borrowers claim that payment constitutes a waiver or forbearance, which they raise to prevent judgment. And unfortunately, many of Ohio’s trial courts accept or consider those waiver or forbearance defenses even where Ohio law forbids them. As a result, the safest course is to reject any payment made after default or maturity. But money not accepted is often money not recovered. Thus where a lender accepts a partial payment from a borrower on a matured loan or a loan in default—that is, a payment for less than the full amount owed—that lender must apply the payment as the borrower instructs. If not, a lender potentially impairs its ability to liquidate the loan.
When presented with a post-default or post-maturity payment, lenders are faced with a difficult decision: accept a partial recovery and risk litigation defenses or reject partial payment on a non-performing loan. Although lenders can mitigate the risk of accepting a partial payment by confirming in writing that the payment didn’t cure or waive anything, many courts will consider that payment a waiver of default—particularly when a lender seeks cognovit judgment.
In the end, a lender must weigh the risks and benefits when faced with a partial payment after default or maturity. Where quick, uncontested liquidation is paramount, reject the payment. Where the payment is substantial or vital to retain, work with your legal counsel to mitigate the risks that arise by keeping those funds.
[1] McGovern v. Landmark Title Agency, Inc., 2nd Dist. Montgomery No. 10765, 1988 Ohio App. LEXIS 4957, *22.
[2] Gaston v. Barney, 11 Ohio St. 506, 510 (1860).
[3] Id.
[4] Stewart v. Hopkins, 30 Ohio St. 503, syllabus (1876).
[5] See, e.g., First National Bank or America v. Pendergrass, 6th Dist. Erie No. E-08-048, 2009-Ohio-3208, ¶ 25 (“a mortgagee’s previous acceptance of late loan payments does not constitute a waiver of the mortgagee’s right to accelerate and foreclose on a loan following a subsequent default where, as here, the relevant loan documents contain ‘anti-waiver’ provisions.”).