Ridgley v. Topa Thrift & Loan Ass'n

• Decision Date: 20 April 1998
• Docket Number: No. S061765,S061765
• Citation: 73 Cal.Rptr.2d 378,17 Cal.4th 970,953 P.2d 484
• Court: California Supreme Court
• Parties: , 953 P.2d 484, 98 Cal. Daily Op. Serv. 2900, 98 Daily Journal D.A.R. 3991 Robert M. RIDGLEY et al., Plaintiffs and Appellants, v. TOPA THRIFT AND LOAN ASSOCIATION, Defendant and Appellant.

Page 378

73 Cal.Rptr.2d 378

17 Cal.4th 970, 953 P.2d 484, 98 Cal. Daily Op. Serv. 2900,

98 Daily Journal D.A.R. 3991

Robert M. RIDGLEY et al., Plaintiffs and Appellants, v. TOPA THRIFT AND LOAN ASSOCIATION, Defendant and Appellant.

No. S061765.

Supreme Court of California.

April 20, 1998.

Jill A. Thomas, West Hills, Lewitt, Hackman, Hoefflin, Shapiro, Marshall & Harlan and Richard M. Hoefflin, Encino, for Plaintiffs and Appellants.

Nebenzahl, Kohn, Davies & Leff, Randall S. Leff, M. Randall Davies and Gerald S. Frim, Los Angeles, for Defendant and Appellant.

WERDEGAR, Justice.

Defendant loaned plaintiffs $2.3 million for two years, secured by real property plaintiffs had improved and intended to sell. Plaintiffs sold the property before the loan matured and, on defendant's demand, repaid the loan principal, together with a prepayment fee of about $113,000, equal to six months' interest. Under the parties' loan agreement, plaintiffs owed defendant a prepayment fee at the time of sale only if plaintiffs had been more than 15 days late with any scheduled interest payment or had defaulted on any other contractual obligation to defendant; the fee was imposed here because plaintiffs had been late with an interest payment.

Plaintiffs sued to recover the prepayment charge they had paid. The question presented is whether such a prepayment charge, conditioned on late interest payments, constitutes an unenforceable liquidation of damages or penalty for late payment of interest (Civ.Code, § 1671, subd. (b); Garrett v. Coast & Southern Fed. Sav. & Loan Assn. (1973) 9 Cal.3d 731, 736-740, 108 Cal.Rptr. 845, 511 P.2d 1197) or an enforceable provision for alternative performance, that is, a surcharge compensating defendant for prepayment of the principal (e.g., Meyers v. Home Sav. & Loan Assn. (1974) 38 Cal.App.3d 544, 546-547, 113 Cal.Rptr. 358). We conclude the trial court correctly understood the prepayment provision here to be a penalty for delinquency in meeting the contractual interest payments and thus correctly held the penalty to be unenforceable, because it bore no relationship to the potential damages defendant would incur from a late interest payment. We therefore reverse the judgment of the Court of Appeal, which reversed the trial court's judgment for plaintiffs.

FACTUAL AND PROCEDURAL BACKGROUND

Plaintiff Robert M. Ridgley is an architect and property developer; plaintiff Marlene Ridgley is his wife. In 1990, as part of Robert's business, he purchased a parcel in Encino (the Property) in order to build a luxury custom home for speculation and sale. Plaintiffs jointly owned the Property. As of late 1990, the construction was almost complete and the home was on the market for sale. The construction loan was coming due and Robert was looking for a bridge loan, i.e., a short term loan between the construction loan and the buyer's permanent loan. A loan broker put Robert in touch with defendant Topa Thrift and Loan Association (Topa).

After negotiation, the parties agreed on the terms of a loan in the amount of $2.3 million. On December 21, 1990, plaintiffs executed a promissory note (the Note), assignment of rents, and deeds of trust in connection with this transaction. Repayment of the principal was due December 21, 1992. Interest payments, at a variable rate of interest, were due monthly on the 21st day of the month. The Note was on a preprinted form supplied by Topa.

The Note, in its preprinted text, contained provision for a prepayment charge, as follows: "Borrower may at any time prepay the outstanding principal balance of this Note in whole or in part; provided, however, Borrower will pay to Lender a prepayment charge of six (6) months' interest at the rate in effect at the time of prepayment on the amount prepaid. Such a prepayment charge will be made whether such prepayments are made voluntarily, involuntarily or upon acceleration of this Note. No such prepayment charge will be made on prepayments made five (5) or more years after the date of this Note."

During negotiations, Robert objected to the five-year prepayment charge provision. In response, Topa inserted a typewritten addendum stating: "PROVIDED ALL SCHEDULED PAYMENTS HAVE BEEN RECEIVED NOT MORE THAN 15 DAYS AFTER THEIR SCHEDULED DUE DATE, AND FURTHER PROVIDED THAT THERE HAVE BEEN NO OTHER DEFAULTS UNDER THE TERMS OF THIS NOTE OR ANY OTHER NOW EXISTING OR FUTURE OBLIGATION OF BORROWER TO TOPA, THEN NO PREPAYMENT CHARGE WILL BE ASSESSED IF THIS LOAN IS PAID IN FULL AFTER June 21, 1991."

Robert requested that an impound fund be established, via a passbook account, for automatic monthly payments. The first 10 payments were automatically made from this account and, when the funds were depleted, Robert timely made the November 21, 1991, payment. In late 1991, Robert contacted Topa to renegotiate the loan for easier payments. As an accommodation to plaintiffs, starting in December 1991, Topa agreed to change the due date from the 21st to the 1st of each subsequent month. Thus, the December 21 payment became due January 1, 1992. Robert made the payment due on January 1 within a 10-day grace period provided for in the agreement, and made no further payment until March 12, 1992.

During January and February 1992, a number of people expressed interest in buying the Property. Robert kept defendant apprised of all of the sale activities, and had ongoing discussions with defendant about further modification or extension of the loan. By February, the Property was in escrow and scheduled to close in April.

On March 3, Topa confirmed its agreement to a modification by letter stating: "Upon receipt and confirmation by TOPA of the above [a copy of the escrow instructions], TOPA agrees to accept the following payment schedule for the months of March and April, 1992; payments of 19,500 to be received by TOPA no later than March 12, 1992 and April 12, 1992." As requested by defendant, Robert provided it with a copy of the escrow instructions and timely made the payment due on March 12.

Topa made a payment demand to the escrow officer for $2,365,502, which included a prepayment charge of $113,046, as well as a demand fee and a late charge purportedly for the March payment, these charges and fees together totaling $114,622. Plaintiffs objected to these assessments. Topa agreed to and did release the deed of trust on the Property and maintained the $114,622 balance as a lien on plaintiffs' house. Plaintiffs ultimately paid off this balance, plus accrued interest, when they refinanced their house.

Plaintiffs sued Topa for breach of contract, money paid by mistake, and fraud. The fraud count was eliminated on Topa's motion for summary adjudication. The remaining causes of action were tried to the court, which ruled as follows: "The Court concludes that the prepayment clause as written by [Topa] was in fact a late charge and a penalty in the nature of an unenforceable forfeiture. Judgment therefore is awarded to [plaintiffs] and against [Topa] in the sum of $114,622.42 as reimbursement for the 'prepayment' paid to defendant by plaintiffs as well as any interest thereon paid to defendant." Judgment was subsequently entered awarding plaintiffs $114,622.42 plus interest paid, prejudgment interest, costs and attorney's fees.

Topa appealed from the judgment for plaintiffs, who also appealed, challenging the adequacy of the attorney's fee award. The Court of Appeal reversed the judgment, concluding the prepayment charge was "not made invalid by conditioning a waiver upon a lack of default. Accordingly, we hold that as the penalty was triggered by the prepayment, it was a valid prepayment provision and was not an invalid late charge or forfeiture." Because it reversed the judgment in plaintiffs' favor, the Court of Appeal did not reach plaintiffs' appeal regarding the amount of attorney's fees awarded them. The dissenting justice would have affirmed the judgment on the same ground it was rendered, i.e., that the prepayment fee conditioned on late interest payments constituted an unenforceable penalty: "[A]fter June 21, 1991, Topa could only assess this fee in the event the Ridgleys defaulted on other terms of the contract. As such, this clause falls squarely within the definition of a penalty or forfeiture which is invalid unless proportionate to the damages sustained." We granted plaintiffs' petition for review.

For the same reasons articulated by the dissenting justice below, we hold the Court of Appeal erred. We reverse and remand for consideration of plaintiffs' appeal.

DISCUSSION

The central question is whether the provision contained in the parties' typewritten addendum should be viewed as a charge for prepayment of the loan principal (the position taken by Topa and the Court of Appeal majority) or as a penalty for delinquency in a monthly interest payment (the position taken by plaintiffs, the trial court and the dissenting Court of Appeal justice). We briefly review the law regarding both late payment penalties and charges for prepayment of principal.

Civil Code section 3275, ¹ unchanged since 1872, provides: "Whenever, by the terms of an obligation, a party thereto incurs a forfeiture, or a loss in the nature of a forfeiture, by reason of his failure to comply with its provisions, he may be relieved therefrom, upon making full compensation to the other party, except in the case of a grossly negligent, willful, or fraudulent breach of duty." The breaching party may raise section 3275 as an equitable defense to enforcement of the contractual provision or as grounds for relief in an action for restitution of the property forfeited. (Freedman v. The Rector (1951) 37 Cal.2d 16, 19-22, 230 P.2d 629; Baffa v. Johnson (1950) 35 Cal.2d 36, 39, 216 P.2d 13; Palo and Dodini v. City of Oakland (1947) 79 Cal.App.2d 739, 748, 180 P.2d 764.)

California law has also long recognized that a provision for liquidation of damages for contractual breach -- for...