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Stipulating to a Large Judgment for Failure to Perform a Settlement Agreement – Why It Can be an Unenforceable Penalty

In my prior post, I discussed a decision concerning a settlement that had had a large penalty for failing to make payments. The court found that it was an unenforceable illegal penalty, and not a legitimate liquidated damages provision. Liquidated damages are damages whose amount the parties agree during the formation of a contract (a settlement agreement is a contract) for the injured party to collect as compensation upon a breach. Sacramento business and real estate attorneys commonly see clients whom, in entering a settlement, want rigid penalties for failure to perform. In a recent decision the parties wisely tried, in a settlement agreement, to establish how their damages provision represented less than the total possible damages amount, and that the provision was to encourage the defendant to make the settlement payments. At the trial level, the defendant did not argue that an unenforceable penalty was involved, and the court ruled against him. On appeal, he tried to claim it was unenforceable. The appellate court, after a review of the law of unlawful penalty provisions, but did not decide whether this case involved a penalty – the defendant waived the argument by not making it in the trial court.

Sacramento-liqudated-damages-attorneyAisha A. Krechuniak v. Zia Jamal Noorzoy involved a brother and sister. The Sister owned property in Pebble Beach and entered a contract with her Brother for the Brother to develop it. He obtained money from investors, and she took out loans to fund the development. The Brother did not use any of the money for development or to pay the mortgages on the property. There was a default and foreclosure.

Sister sued, and at Mediation they entered a settlement that provided for Brother to pay $600,000 in installment payments (relevant settlement language at the end of this post). They also agreed that a stipulated judgment against the Brother in the amount of $850,000 would be executed and held unless and until there is a default in payment.

The Brother defaulted on the payments, and Sister filed a motion to enforce the settlement, seeking to enter the stipulated judgment. At the hearing the Brother did not argue that the settlement agreement contained an illegal penalty provision. The Sister prevailed, and judgment entered. Brother appealed, claiming for the first time that the stipulated judgment was an unenforceable penalty provision.

Sacramento-unenfroceable-penalty-lawyerUnder the old 1872 Civil Code, a provision by which damages for a breach of contract were determined in anticipation of a breach was enforceable only if determining actual damages was impracticable or extremely difficult.

The Code was amended in 1977. It still applies that strict standard to liquidated damages clauses in certain contracts (consumer goods and services, and leases of residential real property (§ 1671, subds. (c), (d)), but eases the rule as to other contracts:

‘[A] provision in a contract liquidating the damages for 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.’ (§ 1671, subd. (b))

Thus, the reasonableness of the provision in hindsight does not matter-it’s only the time of that the contract was entered that counts. The amount of damages actually suffered has no bearing on the validity of the liquidated damages provision.

Sacramento-liqudated-damages-lawyer“All the circumstances existing at the time of the making of the contract are considered, including the relationship that the damages provided in the contract bear to the range of harm that reasonably could be anticipated at the time of the making of the contract.” Among “[o]ther relevant considerations” is “the anticipation of the parties that proof of actual damages would be costly or inconvenient.”

The liquidated damages clause must bear a “reasonable relationship to the range of actual damages that the parties could have anticipated would flow from a breach.”

However, the Brother did not argue in the trial court that this was an unenforceable penalty. If he had, the trial court could have determined whether the parties intended the provision to be one for liquidated damages to the exclusion of the damages that would otherwise be recoverable and, if so, whether the requirements of Civil Code section 1671 were met. Since the Brother did not do so, the Brother could not make this argument on appeal, and the Judgment was not reversed.

In this case, at least one of the parties was familiar with the decision in Greentree Financial Group, and tried to draft around it. One of the proposed settlement agreements provided:

“The parties agree that the stipulated sum of said Judgment does not constitute a ‘penalty’ within the meaning of Greentree Financial Group. Inc. v. Execute Sports. Inc. (2008) 163 [Cal.App.4th] 495, 78 Cal.Rptr.3d 24 [ (Greentree ) ] for several reasons, including but not limited to the following: The stipulated sum represents less the value of the property [sic] located at 952 Sand Dunes, Pebble Beach, CA, Assessor’s Parcel Number 007252015, at the time [Sister] entered into her agreement with [Brother]. It does not include lost profits from the development of that property, interest on the money lost, nor the value of the property lost at 2889 17 Mile Drive, Pebble Beach, CA. Additionally, [Sister] further relinquished her right to trial during which she reasonably expected to achieve a verdict in excess of the stipulated sum. [Sister] agrees to accept substantially less in settlement as an act of kindness towards a family member in order accommodate [Brother]’s attempt to maintain his business and home, as well as the sake of his children. Said Stipulated Judgment is designed to encourage [Brother] to make his settlement payments on time and to compensate [Sister] for the loss of use of the money, her relinquishment of valuable rights and claims for which a substantial likelihood of success exists.”