Filed 8/24/26 (see dissenting opinion)
CERTIFIED FOR PUBLICATION
IN THE COURT OF APPEAL OF THE STATE OF CALIFORNIA
SECOND APPELLATE DISTRICT
DIVISION EIGHT
LAKESHORE INVESTMENT LLC, B343435
Plaintiff and Respondent, (Los Angeles County Super. Ct. No. 19STCV15381)
v.
NOW SOLUTIONS, INC, et al.,
Defendants and Appellants.
APPEAL from a post-judgment order of the Superior Court of Los Angeles County, Tony L. Richardson, Judge. Reversed with directions.
TencerSherman and Philip C. Tencer for Defendants and Appellants.
Gilbert & Nguyen and Jonathan T. Nguyen for Plaintiff and Respondent.
_____________________________
INTRODUCTION
This case addresses the enforceability of a liquidated damages provision within a settlement agreement. Plaintiff Lakeshore Investments (Lakeshore) and Defendants NOW Solutions, Inc. and Vertical Computer Systems (together, NOW) entered into an agreement to settle a lawsuit Lakeshore had brought against NOW Solutions, Inc. The settlement agreement provided that if defendants defaulted on their promise to pay $450,000, they had to pay plaintiff $1.5 million as damages for breaching the settlement agreement. Defendants failed to pay as required. The trial court granted plaintiff’s application for an order that defendants pay $1.5 million for the breach, plus interest. On appeal, defendants argue the $1.5 million represents an unenforceable penalty rather than plaintiff’s true liquidated damages as required by law. We agree and reverse the trial court’s order with directions to determine an amount that represents plaintiff’s damages for the breach.
FACTUAL AND PROCEDURAL BACKGROUND A. The Complaint On January 9, 2013, plaintiff Lakeshore Investments loaned $1,759,000 to NOW Solutions Inc. The loan was documented in a promissory note with an interest rate of 11 percent, secured by an agreement pledging as collateral NOW Solutions’s intellectual property. NOW Solutions defaulted on the loan, leading to eight amendments to the payment schedule. The last amendment dated December 11, 2017, added Vertical Computer Systems (NOW Solutions’s parent company) as a codebtor and guarantor. This amendment set a monthly payment at $31,564 and raised the default interest rate to 16 percent.
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On May 2, 2019, Lakeshore filed a complaint alleging defendants breached the promissory note and security agreement by failing to remit the required monthly payments since January 2018. The complaint sought damages for breach of contract. The prayer for relief sought general, consequential and special damages; prejudgment interest from January 9, 2013, legal fees and costs. B. The Settlement Agreement On November 3, 2023, counsel for the parties reported the parties had entered into a written Settlement Agreement and Mutual Release. Defendants agreed to pay plaintiff $450,000 in three installments over a period of approximately 10 months. The first installment of $30,000 was due on or before December 1, 2023; the second installment of $50,000 was due on or before March 31, 2024; and the third installment of $370,000 was due on or before September 30, 2024. (Plaintiff took on obligations as well which it fully performed.) Defendants admitted no liability with respect to the allegations of the complaint. All parties were represented by counsel who reviewed and approved the agreement as to form. The Settlement Agreement provided that if defendants failed to timely pay an installment and failed to cure the default within 10 business days of receiving a notice to cure, plaintiff would be entitled to a stipulated judgment for damages in the amount of $1.5 million plus interest at the legal rate. The pertinent language of the Settlement Agreement for our purposes is the following: “Defendants shall have ten (10) business days from the date of e-mail notice to cure the default. At any time after the tenth business day following the notice of default, Plaintiff may notify the court of the default. In the event Defendants default, and such default is not cured within ten (10)
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business days, Defendants hereby agree and stipulate to the entry of a judgment against them in the amount of $1,500,000 (one million, five hundred thousand dollars) to bear interest at the legal rate.”
Defendants timely paid $80,000. They failed, however, to pay the remaining balance due of $370,000 and failed to cure the default after receiving the required notice. C. Hearing and Entry of Judgment On November 1, 2024, Plaintiff filed an ex parte application for entry of default and default judgment. On November 5, 2024, defendants filed written opposition to plaintiff’s application for entry of default. Defendants argued the proposed judgment of $1.5 million “is an unenforceable penalty because the amount claimed bears no relationship to the damages Lakeshore could have suffered resulting from failure to pay the original settlement amount.” On November 6, 2024, the parties appeared and argued the application for default and default judgment, which the trial court granted. The court made no specific findings in its judgment other than, “The Court is satisfied with the supporting evidence demonstrating Defendants’ default on October 1, 2024.” Defendants timely appealed.
DISCUSSION
On appeal, defendants argue the trial court erroneously enforced the stipulated damages award of $1.5 million in the settlement agreement, which constitutes an unlawful penalty under California law. We agree.
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A. Applicable Law Civil Code section 1671, subdivision (b) provides: “[A]
provision in a contract liquidating the damages for the breach of the contract is valid unless the party seeking to invalidate the provision establishes that the provision was unreasonable under the circumstances existing at the time the contract was made.”
“A liquidated damages clause will generally be considered unreasonable, and hence unenforceable under [Civil Code] section 1671[, subdivision] (b), if it bears no reasonable relationship to the range of actual damages that the parties could have anticipated would flow from a breach. The amount set as liquidated damages ‘must represent the result of a reasonable endeavor by the parties to estimate a fair average compensation for any loss that may be sustained.’ [Citation] In the absence of such relationship, a contractual clause purporting to predetermine damages ‘must be construed as a penalty.’ ” (Ridgley v. Topa Thrift & Loan Assn. (1998) 17 Cal.4th 970, 977 (Ridgley); Morris v. Redwood Empire Bancorp (2005) 128 Cal.App.4th 1305, 1314; Greentree Financial Group, Inc. v. Execute Sports, Inc. (2008) 163 Cal.App.4th 495, 499 (Greentree Financial).) The “amount of the judgment must reasonably relate to the damages likely to arise from the breach of the stipulation, not the alleged breach of the underlying contract, because it is the breach of the stipulation that allows” judgment to be entered against the defaulting party. (Vitatech Internat., Inc. v. Sporn (2017) 16 Cal.App.5th 796, 810 (Vitatech); Greentree Financial, at p. 499 [the relevant breach to be analyzed is the breach of the stipulation, not the breach of the underlying contract].)
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When a stipulated judgment amount is not reasonably related to damages arising solely from the failure to pay the stipulated judgment, it constitutes an unenforceable penalty. (Purcell v. Schweitzer (2014) 224 Cal.App.4th 969, 974 (Purcell).) B. Standard of Review Whether “the amount to be paid upon breach of a contractual term should be treated as liquidated damages or as an unenforceable penalty is a question of law, which we review de novo.” (Greentree Financial, supra, 163 Cal.App.4th at p. 499.)
We note one recent decision has determined that because resolution of whether the liquidated damages provision is an unenforceable penalty may depend on factual determinations, the question is more appropriately reviewed under the substantial evidence standard, and it becomes a question of law only when undisputed facts support a single reasonable conclusion. (Krechuniak v. Noorzoy (2017) 11 Cal.App.5th 713, 722–724.) There are no disputed facts in the record here so we apply the de novo standard of review. C. Analysis The burden of showing that the liquidated damages provision is invalid in this case falls on defendants NOW. The record contains no facts describing the circumstances existing at the time the settlement agreement was negotiated, other than the existence of the underlying breach of contract action and a statement that the parties arrived at their agreement “following extensive good faith negotiations.” Defendants argue that the $1.5 million liquidated damages provision is not reasonable because it is three times the amount they owed under the settlement agreement and therefore bears no reasonable
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relationship to the range of actual damages that the parties could have anticipated would flow from a breach.
We conclude the $1.5 million default payment amount is a penalty, not an enforceable liquidated damages provision. The record lacks facts establishing that the amount set as liquidated damages ($1.5 million) represents “ ‘the result of a reasonable endeavor by the parties to estimate a fair average compensation for any loss that may be sustained.’ ” (Ridgley, supra, 17 Cal.4th at p. 977.) Plaintiff argues the stipulated judgment was intended to account for its broader damages, including defendants’ poor history of making payments since 2013; defendants’ financial condition at the time of the settlement; the costs of the protracted litigation since the filing of the complaint in May 2019; and the risk in actually collecting a trial judgment. The default term represents a reasonable estimate of a compromised amount moving forward.
Nevertheless, as plaintiff concedes, “there is no demonstrable evidence that these factors were considered, by both sides, in the settlement discussions.” On this record, we decline to presume that such discussions occurred.
We acknowledge that defendants bear the burden of showing that the amount of $1.5 million in liquidated damages is unreasonable because it bears no reasonable relationship to the range of actual damages that the parties could have anticipated would flow from a breach. It is not plaintiffs’ burden to show the amount is reasonable. We conclude that defendants have met their burden by the fact that the $1.5 million is three times the amount of the money due under the settlement agreement. We cannot conceive of actual damages of $1.5 million for breach of this agreement.
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What some might label a “per se unreasonable proportion”
approach in the absence of other evidence of reasonableness is supported by caselaw. In Vitatech, the court found that the stipulated judgment for more than four times the amount Vitatech agreed to accept as full settlement of its claims was an unenforceable penalty as a matter of law where there was no reasonable relationship between the $75,000 settlement amount and the stipulated judgment for more than $300,000. (Vitatech, supra, 16 Cal.App.5th at pp. 800–801.) There, as here, defendants never admitted liability on the underlying claims or the amount of damages allegedly caused by the breach of the underlying contract, and no facts were presented as to the circumstances existing between the parties at the time the parties executed their agreement. (Id. at pp. 810–814.)
Similarly, in Greentree Financial, plaintiff brought an action for breach of contract, alleging a failure to pay $45,000 under the contract. (Greentree Financial, supra, 163 Cal.App.4th at p. 498.) The parties settled the action for a total of $20,000 in two installments. (Ibid.) If defendant defaulted, the amount due was the full amount prayed for in the complaint. (Ibid.) The defendant defaulted on the first installment payment of $15,000. (Ibid.)
In finding that the stipulated judgment was an unenforceable penalty, the Court of Appeal noted the absence of facts showing a reasonable relationship to the range of actual damages that the parties could have anticipated would flow from the breach. (Greentree Financial, supra, 163 Cal.App.4th at pp. 499–500.) There, like here, no facts illuminated how or why the parties arrived at the liquidated damages amount. The Court of Appeal noted that the parties simply selected the amount
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plaintiff had claimed in the underlying lawsuit. This presented a problem because the record showed nothing about the plaintiff’s chances of complete success on the merits of its case. (Ibid.) As is the case here, the record in Greentree Financial included only the complaint and the answer thereto. (Id. at p. 500.) Greentree Financial’s record also included an express disclaimer of liability by each party; here we have a similar absence of admissions of liability. (Ibid.) The Greentree Financial court speculated that the lack of a guarantee of success at trial “may explain” why the plaintiff was willing to accept less than half the amount demanded in the complaint. (Ibid.) It went on to comment that in the absence of a reasonable relationship between the liquidated damages provision and actual anticipated damages for breach of the settlement agreement, the stipulated judgment of more than triple the amount of the settlement was void. (Id. at pp. 500– 501.)
Likewise, in Purcell, the plaintiff, who had settled for $38,000, simply argued that the $85,000 liquidated damage amount reflected the economics associated with “proceeding further” with the lawsuit. (Purcell, supra, 224 Cal.App.4th at p. 976.) The court rejected that approach, finding “There is nothing in the record to support the fact that obtaining a judgment and instituting postjudgment procedures would cost $85,000.” (Id. at p. 976.)
As a second basis for our decision, $1.5 million, on its face, bears no reasonable relationship to the range of actual damages the parties could have anticipated from a breach of the stipulation to settle the dispute for $450,000. As Greentree Financial noted, damages for the withholding of money are easily determinable—i.e., interest at the prevailing rates. (Greentree
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Financial, supra, 163 Cal.App.4th at p. 500.) Plaintiff asks us to compare the damages sought in the original complaint ($1,759,150 plus attorney fees, costs and interest) to the $1.5 million default assessment and conclude that the $1.5 million judgment was appropriate. The caselaw cited above rejects using the damage amount of the original complaint as any sort of yardstick by which to measure damages from breach of the settlement agreement.
Next, the stipulated judgment of $1.5 million would result in an additional assessment of approximately $1 million more than the total due under the settlement agreement. This differential of $1 million fails “to take into account the need for proportion in damages—the critical item in evaluating penalty and forfeiture.” (Sybron Corp. v. Clark Hosp. Supply Corp. (1978) 76 Cal.App.3d 896, 903.) We conclude it is clearly a penalty rather than a reasonable estimate of damage plaintiff could have sustained by defendants’ breach. D. Plaintiff’s Remaining Arguments We note that notwithstanding the 1977 amendments to Civil Code sections 1670 and 1671, courts have steadfastly held that although the Legislature moved the burden of proof to the party challenging a damages provision, the “amendment of the statute does not save a judgment that imposes a penalty bearing no proportional relationship to the damages that might actually flow from a breach.” (Greentree Financial, supra, 163 Cal.App.4th at p. 501, fn. 2, citing Ridgley, supra, 17 Cal.4th at pp. 976–977.)
Plaintiff argues that defendants were represented by counsel and cannot, therefore, claim they did not understand the settlement agreement’s terms. Defendants, however, do not
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contend that they misunderstood the terms of the settlement agreement.
Plaintiff next contends that under California law, represented parties who knowingly stipulate to settlement terms cannot set aside the agreement when one party has already fully performed its obligation, absent evidence of fraud, misrepresentation, or unconscionability. In support of this contention, plaintiff cites In re Marriage of Friedman (2002) 100 Cal.App.4th 65 (Friedman) and In re Marriage of Egedi (2001) 88 Cal.App.4th 17 (Egedi). Plaintiff argues these cases collectively support the notion that stipulated settlement agreements, particularly those where, as here, one party has fully performed, should not be set aside absent compelling equitable considerations, as doing so would undermine fairness and public policy favoring settlements.
Friedman is inapt. It acknowledges that a theoretical and unrealized conflict of interest between husband and wife did not warrant setting aside a postnuptial agreement. Because there was no evidence of fraud, compulsion, actual conflict of interest, illegal purpose or attempted fraudulent conveyance, the agreement could be enforced there. (Friedman, supra, 100 Cal.App.4th at pp. 72–73.) Those factors, however, are not the universe of reasons undermining enforcement of a contractual agreement.
Egedi actually supports defendants’ position. It acknowledges the trial court has the power to invalidate a marital settlement if it is inequitable, even though not induced through fraud or compulsion. (Egedi, supra, 88 Cal.App.4th at pp. 22–23.) Here, a liquidated damages provision lacking a reasonable relationship to the range of damages the parties
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reasonably could have anticipated is unenforceable and void as against public policy, regardless of the presence or absence of fraud or compulsion. (Vitatech, supra, 16 Cal.App.5th at p. 807.)
Plaintiff also cites Rheinhart v. Nissan North America, Inc.
(2023) 92 Cal.App.5th 1016 for the proposition that California has a strong public policy favoring the voluntary settlement of disputes. (Id. at p. 1027.) This is so. Rheinhart acknowledges, however, that “Notwithstanding that policy, courts can declare settlement agreements and releases, which the law treats like any other contracts [citation], void and unenforceable on the basis of other public policies, illegality or unfairness.” (Ibid.)
Finally, plaintiff argues that Code of Civil Procedure section 664.6 does not empower a trial court to modify or alter the terms of a settlement agreement. Plaintiff fails to acknowledge that section 664.6 explicitly provides that the court may enforce the settlement as agreed upon by the parties, but it is not compelled to do so just because the parties agreed upon the terms.
As for the comments in the dissent, we remain faithful to the analysis of the California Supreme Court in Ridgley: “A liquidated damages clause will generally be considered unreasonable, and hence unenforceable under [Civil Code] section 1671[, subdivision] (b), if it bears no reasonable relationship to the range of actual damages that the parties could have anticipated would flow from a breach. The amount set as liquidated damages ‘must represent the result of a reasonable endeavor by the parties to estimate a fair average compensation for any loss that may be sustained.’ [Citation.] In the absence of such relationship, a contractual clause purporting to predetermine damages ‘must be construed as a penalty.’ ”
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(Ridgley, supra, 17 Cal.4th at p. 977.) The record here lacks facts to establish that $1.5 million represents the range of actual damages the parties anticipated would flow from a failure to pay $370,000. Defendants’ position was that liquidated damages of over $1 million per se bore no reasonable relationship to any possible range of damages for breach. We agree with defendants that such a disparity is a penalty and we find their position is supported by the approaches taken by Ridgely, Vitatech, and Greentree Financial.
We also note Gormley v. Gonzalez (2022) 84 Cal.App.5th 72, relied upon by the dissent, held that plaintiffs’ presentation of the dynamics and considerations that resulted in the liquidated damages provision at issue there established a reasonable relationship between the liquidated damages and a fair average compensation for any loss that might have been sustained by the breach of the agreement. In light of the facts plaintiffs presented, the court found defendants, who “submitted no evidence of their own,” had failed to “establish the liquidated damages provision was unreasonable and thus invalid.” (Id. at p. 78.)
Here we have no evidence from any party, other than the over $1 million owed for breaching the agreement. In the interest of justice, we send the matter back to the trial court to take whatever evidence the parties seek to present so that the trial court may calculate a fair average compensation for defendants’ breach.
Defendants do not escape unscathed from their obligations under the settlement agreement. They remain liable for the actual damages resulting from their default. The lender’s charges could be fairly measured by the period of time the money was wrongfully withheld plus the administrative costs reasonably
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related to collecting and accounting for late payment. (Garrett v. Coast & Southern Fed. Sav. & Loan Assn (1973) 9 Cal.3d 731, 741 & fn. 11 [damages from the wrongful withholding of money are fixed by law (Civ. Code, § 3302) and other damages resulting because of a borrower’s default on an installment, such as administrative and accounting costs, would not appear to present extreme difficulty in prospective fixing].) We direct the trial court on remand to conduct a hearing to fix the actual damages caused by defendants’ breach of the settlement agreement.
DISPOSITION
The trial court’s order is reversed with directions on remand to determine reasonable actual damages caused by defendants’ breach of the settlement agreement. Costs are awarded to defendants.
CERTIFIED FOR PUBLICATION
STRATTON, P. J.
I concur:
VIRAMONTES, J.
Wiley, J. dissenting.
The majority opinion has five problems.
1. It misapplies the statute. 2. It conflicts with recent judicial precedent. 3. It is illogical. 4. It is unfair. 5. It will be economically destructive.
I
The majority does injustice to the statute, which is clear as a bell. The statute says “a provision in a contract liquidating the damages for the breach of the contract is valid unless the party seeking to invalidate the provision establishes that the provision was unreasonable under the circumstances existing at the time the contract was made.” (Civ. Code §1671, subd. (b), italics added; (“§1671(b)”).)
Let’s go through this bit by bit. Who is the party seeking to invalidate the provision? That would be defendant and appellant NOW Solutions, Inc., which is a subsidiary of parent corporation and codefendant and appellant Vertical Computer, Inc. Vertical was a publicly traded corporation under the ticker symbol VCSY. For convenience, I refer to these affiliated corporations under the single word Vertical.
How does the statute want us to determine “the circumstances existing at the time the contract was made” (§1671(b), italics added)? A factual presentation would be essential to determine “the circumstances.” (Ibid.) When we ask, “what were the circumstances?” we are asking “what were the facts?” This is plain English.
The statute thus required Vertical to supply a factual showing if it wanted to “invalidate” the liquidated damages provision to which it agreed. (§1671(b).)
Problem number one: Vertical offered no relevant facts. It supplied one declaration by its attorney Ryan Nell that purported to authenticate some documents. This declaration did not otherwise address “the circumstances existing at the time the contract was made.” (§1671(b), italics added.)
In short, Vertical offered no relevant evidence. Because the party seeking to invalidate the provision had the burden but offered no facts about the circumstances, the liquidated damages provision is “valid.” (§1671(b).)
If we attend to the statute, this case is open and shut. The statute also explains why Ridgley v. Topa Thrift & Loan Assn. (1998) 17 Cal.4th 970 (Ridgley) is different from this case.
The statute draws a fundamental distinction between business-to-business deals and consumer cases. When the Legislature amended this statute in 1977, it created “a new general rule favoring the enforcement of liquidated damages provisions except against a consumer in a consumer case. In a consumer case, the prior law under former Sections 1670 and 1671, continued in subdivision (d), still applies.” (Cal. Law Revision Commission com., foll. § 1671, italics added; see Zengen, Inc. v. Comerica Bank (2007) 41 Cal.4th 239, 252 [Commission’s comments are persuasive evidence of the legislative intent].)
The logic of this statutory distinction is plain because the distinction makes sensible generalizations. Consumers rarely retain counsel when taking out a home loan or the like, and the contract they sign usually is something their lender gives them
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on a form. The situation generally is different in the business-tobusiness deal, where sophisticated parties have equal access to legal advice and can negotiate a contract on a fully informed basis. Whatever concerns about the fairness of contract formation that might exist in the consumer situation vanish when one business deals with another on an equal footing.
Ridgley was a consumer case, which the statute treats differently. The loan there was a home loan Topa Thrift & Loan Association made to a married couple named the Ridgleys. The transaction was bank-to-consumer and not business-to-business. The liquidated damages clause was in Topa’s preprinted form. The Ridgleys were not represented by counsel. (Ridgley, supra, 17 Cal.4th at pp. 974–975.)
This case is unlike Ridgley, and the statute states the consumer/non-consumer distinction that proves it. In this statutory case, the words of the statute should be paramount. They dictate affirmance.
II
The majority opinion conflicts with the most recent and authoritative case: Gormley v. Gonzalez (2022) 84 Cal.App.5th 72, 89 (Gormley).) Gormley enforced a liquidated damages clause like this one. Gormley’s thoughtful reasoning should govern.
Gormley involved a lawsuit settlement in which the defendant promised to pay the plaintiffs $575,000. “As incentive to pay the installments as agreed to, the liquidated damages terms were agreed upon.” (Gormley, supra, 84 Cal.App.5th at p. 78.) That was the situation here.
The settlement agreement in Gormley capped liquidated damages at $1.5 million and keyed the exact amount to how much of the debt the defendants had paid. When the defendants
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failed to pay as they had promised, the plaintiffs moved under Code of Civil Procedure section 664.6 “to enforce the settlement agreement, including the liquidated damages provision.” (Gormley, supra, 84 Cal.App.5th at p. 76.) The defendants protested, but—as here—offered no evidence. (Id. at p. 78.) The trial court enforced the liquidated damages provision and entered judgment as the plaintiffs requested in the sum of $1,393,084. The Court of Appeal affirmed this judgment over the defendants’ §1671(b) protest. (Gormley, supra, 84 Cal.App.5th at p. 76.)
Gormley is recent and squarely on point. This thorough and sound opinion distinguished Ridgley and explained why the lower court decisions on which the majority relies were incorrectly decided. (Gormley, supra, 84 Cal.App.5th at pp. 79– 89.)
Gormley likewise explained it is proper to compare the liquidated damages number to the sum the underlying case sought and not to the discount for which the underlying case settled. (Gormley, supra, 84 Cal.App.5th at pp. 86–87.) “We find nothing unreasonable about parties (particularly represented parties) agreeing to settle a lawsuit for a steep discount, and also agreeing that if the settlement amount is not paid, judgment will be entered on the amount the parties estimated would have been recovered at trial.” (Id. at p. 87, italics added.)
Applying Gormley to this case shows errors in the majority’s reasoning. The amount the parties estimated would have been recovered at trial would have dwarfed the $1.5 million figure. We see this by looking at what Lakeshore was seeking in its underlying lawsuit to recover the mounting debt on its loan to Vertical.
Vertical and Lakeshore agreed the liquidated damages were $1.5 million. Lakeshore’s underlying case, filed May 2, 2019, sought damages “in a sum to be determined at the time of trial.” At that time, the complaint alleged Vertical owed Lakeshore a current principal balance of $2,261,324.60. The interest on this unpaid sum was ticking upwards at $1,071.87 a day.
Using Gormley’s proper method—compare the liquidated damage sum to the amount sought at trial—shows this trial court was right to hold Vertical to its deal. The liquidated damages were $1.5 million—in 2019. The amount Lakeshore sought at trial was, as just stated, $2,261,324.60—in 2019. With interest at $1,071.87 a day, that sum ballooned to $4,421,142.65 on the date when the trial court signed the order under review, which was November 6, 2024. (This figure is simple arithmetic: count the days and multiply by the daily amount.) And the lost interest caused by Vertical’s delay in payment has inexorably ticked upwards every day since then. Compared to $4.4 million, $1.5 million was reasonable.
The familiar rule is that we imply findings to support the judgment. This judgment was sound. We should support it.
According to Gormley, then, the majority errs by comparing $1.5 million to a mere $450,000, which was the “steep discount” at which Lakeshore finally decided to settle this case. (Gormley, supra, 84 Cal.App.5th at p. 87.)
III
The majority result is illogical. It offers a paternalistic hand to a deadbeat corporation to get it out of the bed it made for itself. The corporation’s lawyers helped it make the bed. Why on earth help this party?
As Judge Posner dryly remarked, “[T]he refusal to enforce penalty clauses is (at best) paternalistic—and it seems odd that courts should display parental solicitude for large corporations.” (Lake River Corp. v. Carborundum Co. (7th Cir. 1985) 769 F.2d 1284, 1289 (Lake River).)
The scholarly literature has been hard on the approach the majority takes, and on precisely Judge Posner’s ground: when corporate lawyers guided a corporate client in making its solemn and considered commitment, why help that corporation break its promise?
As Gormley explained, California revised its statute in 1977. (See Gormley, supra, 84 Cal.App.5th at p. 80.)
In 1977 it was becoming plain the intellectual foundation for the old law was rotten. The better rule, the sound and usual rule, is to enforce contracts as they are written when sophisticated parties represented by counsel drafted the document. Doing otherwise invites socially destructive mischief.
In 1972, Stanford Professor John H. Barton explained “that in evaluating the enforceability of a liquidated damages clause a court should inquire not into the uncertainty of estimating damages beforehand or the consistency of the clause with the traditional law of damages, but only whether the provision was knowledgeably and fairly bargained for. I do not deny that the test classically used to distinguish an imposed ‘penal damage’ clause (which will not be enforced) from a negotiated ‘liquidated damage’ clause (which will be enforced) may be useful evidence of the fairness of the bargaining. It is clear, however, that courts are acting improperly in ignoring a liquidated damage clause if their ground is that the parties are setting their own law. Liquidated damage clauses can reasonably be rejected only on a
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basis that the negotiation (or its reduction to writing) was unfair in some way.” (Barton The Economic Basis of Damages for Breach of Contract (1972) 1 J. Legal Studies 277, 286–287.)
In 1977, a similar analysis concluded that “many people may not want to make deals unless they can shift to others the risk that they will suffer idiosyncratic harm or otherwise uncompensated damages. To the extent that the law altogether prevents such shifts from being made or reduces their number by unnecessarily high costs, it creates efficiency losses; that is, it prevents some welfare increasing deals from being achieved.” (Goetz & Scott Liquidated Damages, Penalties and the Just Compensation Principle: Some Notes on an Enforcement Model and a Theory of Efficient Contract Remedy (1977) 77 Columbia Law Review 554, 583.)
On the wave of this scholarship, the Legislature revised the governing statute in 1977. This scholarship informs our state statute.
Judge Posner summarized this scholarship by observing that “the parties (always assuming they are fully competent) will, in deciding whether to include a penalty clause in their contract, weigh the gains against the costs—costs that include the possibility of discouraging an efficient breach somewhere down the road—and will include the clause only if the benefits exceed those costs as well as all other costs.” (Lake River, supra, 769 F.2d at p. 1289.)
As the statute directs, when sophisticated corporations aided by counsel negotiate a contract, courts should enforce it by its terms unless the complaining party can explain how the negotiation process was unfair. Vertical offered no evidence of this kind. There was no form contract: the words were
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negotiated with the aid of counsel. This is plain from the 10-page settlement agreement itself. Respondent Lakeshore Investment LLC properly put this settlement agreement into evidence in the trial court. Vertical never objected to this evidence, and offered no evidence of its own. During contract negotiations with Lakeshore, Vertical had full access to its team of corporate attorneys.
So when a publicly traded corporation represented by lawyers in a fair bargaining process agreed it was reasonable to set its liquidated damages at $1.5 million, why are we disagreeing? Where is the logic in that?
The majority does not attempt to explain the logic of its holding. Why would the California Legislature write a law to help a corporation like Vertical, with all its lawyers, to break its promise on repaying its debt? What public policy could that possibly serve?
IV
The majority result is unfair. Vertical owed money to Lakeshore and, to get forbearance, promised to pay liquidated damages in the event of default. Now Vertical is claiming what it offered is invalid. This is a “hey neener neener, gotcha sucker” defense. (Gormley, supra, 84 Cal.App.5th at p. 89.) This opportunistic trickery is unfair.
Recall Lakeshore alleged, without contradiction in the record, that it made this $1,759,150.00 loan to Vertical in 2013. Lakeshore has been trying for 13 years to collect this debt. But 13 years is not enough delay. Today the majority remands for further proceedings—further delays, further attorney fees, further costs, further lost interest. The unfairness is acute.
The majority does not attempt to portray this result as fair.
This is because it cannot.
V
The majority result will be economically destructive. Lenders in the future will be more reluctant to help corporate borrowers in their times of need if lenders cannot enforce their arm’s length deals according to the negotiated terms. Denying enforcement of the deal as written will create harmful effects: fewer loans, or loans at higher rates.
Liquidated damage clauses perform a valuable economic function. Judge Posner gives pertinent examples. “Suppose I know that I will honor my contracts, but I find it difficult to convince others of this fact. By signing a penalty clause I communicate credible information about my own estimate of my reliability—information useful in determining on what terms to do business with me. ¶ Another reason for a penalty clause is to compensate the seller for a high risk of default. Suppose defaulting buyers will often be insolvent or otherwise unable to cover the seller’s full damages. Then the ‘windfall’ recovery of a penalty in some cases will, by offsetting losses incurred in others, enable sellers to take greater risks and charge lower prices.” (Posner, Economic Analysis of Law (9th ed. 2014) pp. 140–141, italics added.)
Liquidated damages clauses thus enable private parties to strike agreements beneficial to the wider economy and to our society as a whole, which depends on private ordering for its material wellbeing. Refusing to enforce those agreements as they are written will harmfully reduce these benefits.
Imagine you ran a business with a cash flow problem and you were seeking a loan to keep you going until expected
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revenues arrived. If your prospective lender reads the majority opinion, the effect would be to make the lender less willing to loan you funds at a favorable rate. The majority opinion will make business loans riskier and thus more expensive, because a deal is no longer a deal but instead a lawsuit. In the long run, increasing risk and the cost of credit is harmful. It helps no one.
+ + + + + + +
I dissent because, by misapplying the statute and departing from recent precedent, the majority reaches a result at once illogical, unfair, and destructive. I respect and admire my dear colleagues, and for these reasons view their decision with puzzlement and dismay. I recommend Lakeshore seek further review.
WILEY, J.