Dobson Bay Club II DD, LLC v. La Sonrisa de Siena, LLC
393 P.3d 449 (2017)
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Rule of Law:
A liquidated damages provision that assesses a large, fixed-percentage late fee on a final loan balloon payment is an unenforceable penalty if other contract terms, such as default interest and collection costs, already compensate the non-breaching party for its primary losses.
Facts:
- In 2006, Canadian Imperial Bank of Commerce loaned Dobson Bay Club II DD, LLC and related entities ('Dobson Bay') $28.6 million for the purchase of four commercial properties.
- The promissory note required interest-only payments until a final 'balloon' payment of the entire principal became due.
- The loan agreement stipulated that a late payment, including the final balloon payment, would incur a 5% late fee, in addition to regular interest, default interest, and all collection costs.
- The parties extended the loan's maturity date to September 2012.
- As the 2012 maturity date approached, the parties were unable to agree on a further extension.
- Dobson Bay failed to make the balloon payment on the September 2012 maturity date.
- After Dobson Bay's default, La Sonrisa de Siena, LLC ('La Sonrisa') purchased the promissory note and deed of trust from Canadian Imperial Bank.
Procedural Posture:
- La Sonrisa initiated a trustee's sale of the secured properties after Dobson Bay's default, prompting litigation over the late fee.
- In the superior court (trial court), the parties filed cross-motions for partial summary judgment on the enforceability of the late fee.
- The superior court granted partial summary judgment in favor of La Sonrisa, upholding the late fee as enforceable liquidated damages.
- Dobson Bay, as the appellant, appealed the decision to the Arizona Court of Appeals.
- The court of appeals reversed the trial court's decision, holding that the late fee was an unenforceable penalty as a matter of law.
- La Sonrisa, as the petitioner, was granted review by the Supreme Court of Arizona.
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Issue:
Does a 5% late fee assessed on a final loan balloon payment of approximately $28.6 million constitute an unenforceable penalty when the loan agreement also provides for default interest and the recovery of all collection costs?
Opinions:
Majority - Justice Timmer
Yes, the 5% late fee constitutes an unenforceable penalty. The court adopted the Restatement (Second) of Contracts § 356(1) test, which assesses reasonableness based on anticipated or actual loss and the difficulty of proving that loss. The court reasoned that the fixed 5% fee, amounting to nearly $1.4 million, was not a reasonable forecast of damages because it was a static amount regardless of the delay's duration. Furthermore, the contract already compensated the lender for its primary losses through other provisions: default interest compensated for the 'loss of use' of the money, and clauses requiring payment of collection costs, trustee's fees, and attorney fees covered the administrative expenses of the default. Because the lender's actual damages were not difficult to prove and were substantially covered by other remedies, the grossly disproportionate late fee served as a penalty rather than a reasonable measure of compensation.
Dissenting - Justice Bolick
No, the 5% late fee does not constitute an unenforceable penalty. The dissent argued that the majority's decision undermines the principle of freedom of contract between sophisticated parties. It contended that liquidated damages provisions in commercial contracts should be presumptively reasonable, with a substantial burden on the challenging party to prove otherwise—a burden Dobson Bay failed to meet. The dissent emphasized that the late fee reasonably compensates for hard-to-calculate 'opportunity costs' that are not covered by default interest or collection fees, such as the inability to reinvest the principal into new loans. Given that a 5% fee is standard in the commercial lending industry for such defaults, the court should have deferred to the parties' freely negotiated agreement rather than invalidating a core term of the contract.
Analysis:
This decision officially adopts the Restatement (Second) of Contracts § 356(1) as the standard in Arizona for evaluating liquidated damages clauses, aligning state law with the Uniform Commercial Code. The ruling establishes a significant precedent that fixed-percentage late fees on loan balloon payments are highly susceptible to being invalidated as unenforceable penalties, particularly when other remedies for default are present. Lenders in Arizona must now be more cautious, likely shifting towards fees that are more closely tied to the duration of the default or the actual, demonstrable administrative costs incurred, rather than relying on large, flat-rate percentages on principal balances.
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