California Supreme Court Upholds Penalties for Delinquent Loan Payments

The Supreme Court of California let stand its decision in Honchariw v. FJM Private Mortgage Fund LLC (83 Cal.App.5th 893) (2022), throwing doubt on a lender's ability to charge a late fee and default interest on an unpaid principal balance following a delinquent loan payment.

The Honchariw Case

In Honchariw, a borrower failed to make a timely loan payment. The Honchariw loan documents provided for the following:

• A 10% late charge assessed against the overdue amount.
• A 9.99% interest charge on the entire unpaid principal balance for failure to timely make the monthly payment.

The Honchariw loan documents also included the customary provision that late fees and default interest are assessed because the borrower's default "will result in [the lender] incurring additional expense in servicing the loan, including, but not limited to sending out notices of delinquency, computing interest, and segregating the delinquent sums from not delinquent sums on all accounting, loan, and data processing records, in loss to [the lender] of the use of the money due, and in frustration to [the lender] in meeting its other financial commitments."

The Honchariw court held "liquidated damages in the form of a penalty assessed during the lifetime of a partially matured note against the entire outstanding loan amount are unlawful penalties" and held that the late charge and default interest were unlawful penalties.

The Honchariw court also held that "blanket statements in loan documentation are insufficient to support a finding that [the lender] had attempted to estimate [the lender's] damages in the amount of breach." For this reason, the late charge and default interest were not rendered enforceable by language in the loan documents to the effect that the lender's damages would be difficult to estimate in the event of borrower default.

The Honchariw court premised its holding on the idea that liquidated damages must bear a reasonable relationship to the actual damages sustained by the injured party and must be the result of a reasonable endeavor to estimate such actual damages. Also, the Honchariw court seemed to focus on the fact that, pursuant to the loan documents, a single late payment triggered 9.99% default interest, which interest was assessed against not only the amount of the delinquent payment, but also against the entire unpaid principal balance of the loan. The court stated that there is no case law "in which a liquidated damages provision was upheld when a borrower missed a single installment, and then was penalized pursuant to that provision, even in part, by a late-payment fee assessed upon the entire outstanding principal balance, much of it still to be owed."

It is interesting to note that, although the Honchariw court invalidated both the 10% late charge and the default interest, the Honchariw court's analysis seems to be aimed only at the default interest and not at the late charge. Additionally, the opinion does not directly address the enforceability of a more typical late charge of 5% on a delinquent payment, or whether default interest can be charged on the delinquent amount (as opposed to the entire unpaid principal balance).

Takeaways

Importantly, the Honchariw court made a distinction for default interest assessed against the entire outstanding principal balance where a borrower defaults on a fully matured loan; such default interest does not constitute an unlawful penalty and is enforceable.

Honchariw-which is now final case law-will certainly cause lenders to revisit late assessments and delinquent interest charges in loan documents and borrowers to rethink their lawyers' opinions.

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