Dobson Bay Club II DD, LLC v. La Sonrisa De Siena, LLC (4/25/2017)

May 8, 2017

Arizona Supreme Court holds that a 5% late fee for a balloon payment on a commercial loan did not approximate the anticipated or actual loss from late payment, and therefore was not enforceable as liquidated damages.

A bank loaned a business $28.6 million to purchase four commercial properties.  The business owed interest-only payments until the loan matured, when the entire principal became due.  If the business paid late, it would owe default interest, collection costs, and a 5% late fee.  The maturity date passed and the business did not pay the balloon payment.  Litigation ensued, and the superior court held that the late fee was enforceable as liquidated damages.  The court of appeals reversed, holding as a matter of law that absent unusual circumstances, a 5% late fee on a balloon payment is not enforceable as liquidated damages. 

The Supreme Court granted review and found the late fee unenforceable on the facts.  The Court adopted the test in Restatement (Second) of Contracts, § 356(1), under which a liquidated damages provision is enforceable, “but only at an amount that is reasonable in the light of the anticipated or actual loss caused by the breach and the difficulties of proof of loss.”  The Court held that the 5% late fee did not reasonably forecast anticipated damages because it duplicated other late fees and was unrelated to the length of the delay.  The Court also held that the 5% late fee did not approximate actual damages because the record reflected no significant administrative costs associated with the late payment and the default interest compensated the lender for the loss of the use of money.  The Court further concluded that the bank would have little difficulty proving any loss.

The Court, therefore, held that the bank could not collect the 5% late fee, but that it could seek actual damages.  The Court vacated the court of appeals’ opinion, reversed the trial court, and remanded.

Justice Timmer authored the opinion of the court, in which Chief Justice Bales, Vice Chief Justice Pelander, and Justice Brutinel joined.

Justice Bollick dissented.  He explained that because the Arizona Constitution prohibits laws “impairing the obligation of a contract,” Ariz. Const. art. II, § 25, courts must indulge every presumption in favor of upholding a contract negotiated by sophisticated parties represented by competent counsel.  Justice Bollick concluded that the liquidated damages term was a reasonable method of inducing performance and compensating the bank for risk and opportunity cost and its inability to use the repayment as planned.  He also expressed concern that the majority’s decision casts doubt on many commercial loan contracts, which have similar late fees.