When is a “Pay Off” Request to a Lender Not a Pay Off?

If you’re in banking, what would you typically do when your bank is refinancing a loan for a customer?  The procedures vary from bank to bank but would at the least include the following two steps: (1) getting your client to request a payoff amount from the current lender and (2) making sure you get a “payoff letter” an “estoppel letter” from the current lender (so that the amount refinanced would be fixed and the bank and its closing agent would know how much to refinance to payoff the current loan).  Sounds fairly straight forward but it can be more complicated when refinancing a line of credit.

As everyone knows and common sense dictates, without more, a mere payment of the all amount owed under a line of credit does not necessarily terminate the line of credit.  The line of credit remains with a balance of zero.  There is a little known line of cases requiring that the borrower must specifically request that the line be terminated.  Usually, these cases originate from states with specific statute in the context of mortgages involving line of credits.1  What if the loan a bank refinanced only secured personal property, would that same standard still hold?  Yes, it may and it certainly did in one recent bankruptcy case.2  In a local bankruptcy case in Tampa, the judge found that a payoff request was insufficient to terminate the first line of credit despite the fact that the refinancing bank paid off the exact amount sent in the “estoppel letter.”

When does this matter? When the original lender failed to file a UCC-3 termination statement and the refinancing bank fails to notice this problem until too late.  In the recent case I was involved in, the original lender (a large national bank) failed to file the UCC-3 as per the request of the refinancing bank’s closing agent.  Worse yet, that first bank eventually realized that it still had a valid UCC-1 statement and thus approached the borrower with an offer of financing under its original line.  If the borrower is financially struggling, the odds are great that that borrower will draw on the still open line of credit and leave the banks to fight for priority in the courts.

If you find yourself in bankruptcy court asking a judge to decide on the priority of loans, it is highly likely that the losing party will find itself classified as an unsecured creditor.

The moral of the story is that a bank which is refinancing a line of credit should include in its form payoff letter a sentence stating “I specifically request the termination of my line of credit.”  Another practical solution is to file the UCC-3 termination on behalf of the lender that the bank is refinancing.  These easy precautions may just save a bank great losses and litigation costs in the future.

This applies equally to a borrower.  If you intend to terminate a line of credit, make sure you specifically send a letter to the lender stating clearly and unequivocally that you are terminating the line of credit.  Otherwise, the bank may treat your payment is as pay down of the balance to zero and keep the loan open against your wishes.

Which of us wants an open line when we think we’re actually terminating it?  That open line of credit may still show up on your credit report, impacting your score.  Worse yet, you may be a victim of identity theft and that criminal may have access to a line of credit you thought you had terminated.

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1 E.g., Illinios – Ill. Rev. Stat. 1989, chapter 17.
2 In re Seascape Aquarium, Inc., Case No. 8:12-bk-15215-MGW.