Dobson Bay Club II DD, LLC v. La Sonrisa De Siena, LLC

• Decision Date: 28 January 2016
• Docket Number: No. 1 CA–CV 13–0709.,1 CA–CV 13–0709.
• Citation: 366 P.3d 1022
• Parties: DOBSON BAY CLUB II DD, LLC, a Delaware limited liability company; Dobson Bay Club III KD, LLC, a Delaware limited liability company; Dobson Bay Club IV KG, LLC, a Delaware limited liability company; and Darby AZ Portfolio, LLC, a Delaware limited liability Company, Plaintiffs/Appellants v. LA SONRISA DE SIENA, LLC, an Arizona limited liability company, Defendant/Appellee.
• Court: Arizona Court of Appeals

366 P.3d 1022

DOBSON BAY CLUB II DD, LLC, a Delaware limited liability company; Dobson Bay Club III KD, LLC, a Delaware limited liability company; Dobson Bay Club IV KG, LLC, a Delaware limited liability company; and Darby AZ Portfolio, LLC, a Delaware limited liability Company, Plaintiffs/Appellants

v.LA SONRISA DE SIENA, LLC, an Arizona limited liability company, Defendant/Appellee.

No. 1 CA–CV 13–0709.

Court of Appeals of Arizona, Division 1.

Jan. 28, 2016.

Lewis Roca Rothgerber LLP, By Brian J. Pollock, Jared L. Sutton, Phoenix, Counsel for Plaintiffs/Appellants.

Schern Richardson Finter Decker, PLC, By Michael A. Schern, Mark A. Hanson, Mesa, Counsel for Defendant/Appellee.

Judge MICHAEL J. BROWN delivered the opinion of the Court, in which Presiding Judge PETER B. SWANN and Judge KENTON D. JONES joined.

OPINION

BROWN, Judge:

¶ 1 Dobson Bay Club II DD, LLC, et al. ("Dobson Bay") appeals the trial court's entry of partial summary judgment in favor of La Sonrisa De Siena, LLC ("La Sonrisa") on Dobson Bay's claim for declaratory relief concerning the enforceability of a late fee provision in a promissory note. The sole issue before us is whether the court erred in concluding La Sonrisa is entitled to recover a $1.4 million late fee on Dobson Bay's delinquent balloon payment as liquidated damages. For the following reasons, we hold that the late fee constitutes a penalty and is therefore unenforceable.

BACKGROUND

¶ 2 In 2006, Dobson Bay entered into a loan agreement with Canadian Imperial Bank of Commerce ("Canadian Imperial"). As set forth in the agreement, Canadian Imperial loaned Dobson Bay $28.6 million, with a maturity date of September 8, 2009. The loan funded Dobson Bay's acquisition of four commercial properties located in Maricopa County and was secured by a deed of trust, assignment of leases and security agreement. As outlined in Article II of the promissory note, Dobson Bay was permitted to tender interest-only installment payments, with the "entire outstanding principal amount" due on the maturity date. Article IV of the promissory note included a late-fee provision, which stated:

If any installment payable under this Note (including the final installment due on the Maturity Date) is not received by Lender prior to the calendar day after the same is due (without regard to any applicable cure and/or notice period), Borrower shall pay to Lender upon demand an amount equal to the lesser of (a) five percent (5%) of such unpaid sum or (b) the maximum amount permitted by applicable law to defray the expenses incurred by Lender in handling and processing such delinquent payment and to compensate Lender for the loss of the use of such delinquent payment, and such amount shall be secured by the Loan Documents.

The promissory note also provided that in the event of default, Dobson Bay would pay default interest plus costs of collection including reasonable attorneys' fees. The deed of trust further stated that if a foreclosure proceeding were initiated, Dobson Bay would pay attorneys' fees, trustee's fees, and costs related to the foreclosure.

¶ 3 In 2009, Dobson Bay and Canadian Imperial negotiated an extension of the loan, with a new maturity date of September 8, 2012. During the summer of 2012, Dobson Bay and Canadian Imperial began to negotiate another loan extension, but failed to reach an agreement. On October 22, Canadian Imperial sent Dobson Bay a notice of default. On November 28, Canadian Imperial informed Dobson Bay it had assigned the promissory note and deed of trust to La Sonrisa. La Sonrisa then commenced a foreclosure proceeding by recording a notice of trustee's sale. La Sonrisa provided Dobson Bay a loan payoff statement reflecting a principal balance due of $27,778,698.07, plus regular interest, default interest, a late fee of $1,392,784.90 (5% of the balloon payment), and legal fees of $9,284. La Sonrisa later requested payment of approximately $60,000 in additional attorneys' fees and $140,000 in trustee's fees.

¶ 4 Dobson Bay subsequently obtained new financing and paid La Sonrisa the outstanding loan balance. Dobson Bay disputed, however, the loan payoff amount, including La Sonrisa's entitlement to the late fee. La Sonrisa therefore declined to release the deed of trust. Litigation followed, with Dobson Bay seeking, among other things, a declaratory judgment that it was entitled to a release of the deed of trust and that La Sonrisa was not entitled to recover the late fee.¹ The parties cross-moved for partial summary judgment regarding enforceability of the late fee. The trial court granted partial summary judgment in favor of La Sonrisa under Arizona Rule of Civil Procedure 54(b), finding that the late fee was enforceable as liquidated damages because it reasonably forecasted the harm caused by default and the harm was otherwise difficult to accurately estimate. Dobson Bay timely appealed.

DISCUSSION

¶ 5 Summary judgment is appropriate if there is no genuine dispute as to any material fact and the moving party is entitled to judgment as a matter of law. Ariz. R. Civ. P. 56(a). We review a superior court's grant of summary judgment de novo. Link v. Pima Cty., 193 Ariz. 336, 340, ¶ 12, 972 P.2d 669, 673 (App.1998). If we reverse a grant of summary judgment, we may direct entry of judgment in favor of a party filing a cross-motion for summary judgment with identical legal issues that can be decided as a matter of law. See Roosevelt Sav. Bank of City of N.Y. v. State Farm Fire & Cas. Co.,

27 Ariz.App. 522, 526, 556 P.2d 823 (1976).

A. Enforceability of Liquidated Damages Provisions

¶ 6 Dobson Bay contends the $1.4 million late fee is unreasonable as a matter of law. In addition to being "vastly disproportionate" to La Sonrisa's actual damages, Dobson Bay asserts that enforcement of the late fee would create a windfall because La Sonrisa has "already been compensated" for its damages under the separate default interest, attorneys' fees, and trustee's fees provisions of the note and deed of trust. La Sonrisa counters that the late fee should be upheld as an enforceable liquidated damages provision, negotiated as part of an arms-length business transaction. Citing the sole expert opinion presented to the trial court, La Sonrisa also contends the fee is reasonable.

¶ 7 Dobson Bay does not dispute that it breached a material term of the promissory note by failing to timely pay the balance of the loan. Thus, according to Article IV of the note, Dobson Bay was obligated to pay the noteholder "the lesser of (a) five percent (5%) of such unpaid sum or (b) the maximum amount permitted by applicable law to defray the expenses incurred by Lender in handling and processing such delinquent payment and to compensate Lender for the loss of the use of such delinquent payment[.]" Because La Sonrisa has made no claim or argument that it is entitled to actual damages under subpart (b) of the late-fee provision, we consider only whether it is entitled to recover 5% of the final balloon payment under Arizona law governing liquidated damages.

¶ 8 The principal reason parties include liquidated damages provisions within contracts is to avoid proof and other calculation issues involved in litigating what a reasonable damage award would be in the event a breach occurs, especially when the amount in controversy is small. See Roscoe–Gill v. Newman, 188 Ariz. 483, 485, 937 P.2d 673, 675 (App.1996) ; see also Mech. Air Eng'g Co. v. Totem Constr. Co., 166 Ariz. 191, 193, 801 P.2d 426, 428 (App.1989) (explaining that a "liquidated damage clause promotes enterprise by increasing certainty and by decreasing risk-exposure, proof problems, and litigation costs"); Restatement (Second) of Contracts § 356(1) (1981) ("Restatement"). Whether a liquidated damages provision is enforceable depends upon the particular circumstances of each case. See Pima Sav. and Loan Ass'n v. Rampello, 168 Ariz. 297, 300, 812 P.2d 1115, 1118 (App.1991).

¶ 9 Arizona courts have generally followed the test described in the Restatement of Contracts to determine whether a contractual provision that establishes an amount of damages in advance is reasonable, and therefore enforceable. As explained in Larson–Hegstrom & Associates v. Jeffries, an agreement setting the amount of damages in advance of a breach is an unenforceable penalty unless (1) the amount fixed is a reasonable forecast of just compensation for harm caused by the breach, and (2) the harm caused is "incapable or very difficult of accurate estimation." 145 Ariz. 329, 333, 701 P.2d 587, 591 (App.1985) (citing Restatement (First) of Contracts § 339 (1932) ). In 1981, the test was reframed as follows:

Damages for breach by either party may be liquidated in the agreement 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. A term fixing unreasonably large liquidated damages is unenforceable on grounds of public policy as a penalty.

Restatement § 356(1).²

¶ 10 The Restatement's revised framing of the inquiry is consistent with the "compensatory, not punitive" objective of contract remedies. See Restatement § 356 cmt. a. A contractual provision "fixing unreasonably large liquidated damages," which clearly exceed compensatory damages, "is unenforceable on grounds of public policy as a penalty." Restatement § 356(1). Thus, the touchstone of a liquidated damages clause is reasonableness. See Wasserman's Inc. v. Twp. of Middletown, 137 N.J. 238, 645 A.2d 100, 107 (1994) ("Two of the most authoritative statements concerning liquidated damages are contained in the Uniform Commercial Code and the Restatement (Second) of Contracts, both of which emphasize reasonableness as the touchstone.").

¶ 11 La Sonrisa argues that the liquidated damages fee at issue should be enforced because two sophisticated parties, both represented by counsel, specifically agreed to the 5% late fee. Refusing to enforce late fees, according to La...