Liquidated Damages – California

May 26, 2021

The following is a case update written by Leonard Gumport analyzing a recent case of interest.

SUMMARY

In Graylee v. Castro, 52 Cal. App. 5th 1107 (2020) (“Graylee”), the California Court of Appeal ruled that California Code of Civil Procedure section 664.6, which allows a court to enter a judgment under the terms of a settlement of pending litigation, does not authorize a court to enter or enforce a judgment that contains an invalid liquidated damages clause. A copy of the Graylee decision is here.

FACTUAL BACKGROUND

In May 2015, John and Rosa Castro (the “Castros”) leased a residential property in Anaheim, California from Fred Graylee (“Graylee”). The monthly rent was $3,195. In June 2018, Graylee served the Castros with a three-day notice to pay rent or quit. In the notice, Graylee alleged that the Castros owed $27,170 in unpaid rent. On July 3, 2018, Graylee filed an unlawful detainer action against the Castros. On August 2018, Graylee filed a first amended complaint, which sought $27,170 in past-due rent, reasonable attorney’s fees, and forfeiture of the lease agreement. In an answer, the Castros disputed Graylee’s complaint and asserted affirmative defenses, including that Graylee had accepted rent from the Castros. Trial was scheduled for October 2, 2018.

On the trial date, Graylee and Castros filed a handwritten stipulation (the “Stipulation”) on a preprinted form for entry of judgment. The trial court approved the Stipulation on the same day. The Stipulation required the Castros to vacate the property by 3:00 p.m. on October 31, 2018, and to leave the property in broom-swept condition. The Stipulation provided that a $28,970 judgment for unpaid rent, damages, and attorney’s fees and costs would be granted against the Castros “only if” they failed to comply with the Stipulation. The Stipulation provided that, if the Castros timely vacated the property, then Graylee would waive the $28,970 money judgment; if the Castros failed to comply, then the full judgment amount of $28,970 would be due. In the Stipulation, the Castros waived all claims against Graylee through the date of the Stipulation.

In January 2019, Graylee filed a motion for entry of a stipulated judgment for $28,970 against the Castros. The motion was supported by a declaration from Graylee’s property manager, who stated that the Castros vacated the property one day after the October 31, 2018 deadline and did not leave the property in broom-swept condition. The declaration did not provide details about how the property fell short of the broom-swept condition requirement. The Castros opposed Graylee’s motion and alleged that they had timely vacated.

On June 10, 2019, after an evidentiary hearing, the trial court found that the Castros did not vacate the property by the October 31, 2018 deadline. Pursuant to the Stipulation, the trial court entered a judgment for $28,970 against the Castros. On September 26, 2019, the trial court vacated that judgment and entered an amended judgment (“Stipulated Judgment”) for $28,970 against the Castros pursuant to the Stipulation. They appealed. On July 13, 2020, the Court of Appeal reversed the Stipulated Judgment.

REASONING

In Graylee, the Court of Appeal began its analysis by deciding whether Code of Civil Procedure section 664.6, which authorizes stipulated judgments to settle pending litigation, is an exception to Civil Code section 1671, which prohibits enforcement of unreasonable liquidated damages clauses. Section 664.6 allows a court to enter a judgment under the terms of a settlement agreement, and, if requested, to retain jurisdiction to enforce the settlement.

Graylee rejected the landlord’s contention that section 664.6 is an exception to the prohibition in Civil Code section 1671(b) on unreasonable liquidated damages clauses. Section 1671(a) states that it “does not apply in any case where another statute expressly applicable to the contract prescribes the rules for determining the validity” of the liquidated damages provision. The terms of section 664.6 do not allow a court to endorse or enforce a provision of a settlement agreement or stipulation that is illegal, contrary to public policy, or unjust. Unenforceable liquidated damages provisions are void as against public policy. A stipulated judgment that includes an unlawful liquidated damages provision is void and may be vacated. Graylee, 52 Cal. App. 5th at 1114.

The Stipulation contained a liquidated damages provision, even though the Stipulation did not use the words “liquidated damages.” Liquidated damages are the compensation to be paid in the event of a breach of contract, the amount of which is fixed by agreement and may not ordinarily be altered when the damages actually resulting from the breach are different from the agreed upon amount. Courts look beyond the language of a contract to determine the actual circumstances of a liquidated damages clause. The $28,970 monetary provision of the Stipulation was a liquidated damages clause because the Stipulation “predetermined the amount of damages the landlord would be entitled to receive if the tenants breached their settlement obligations.” Id. at 1114. It was irrelevant that the Stipulation did not use the phrase “liquidated damages.” Id.

Under Civil Code section 1671(b), a liquidated damages provision “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.” The liquidated damages provision must represent a reasonable endeavor by the parties to estimate a fair average compensation for any loss that may be sustained. Otherwise, the clause will be construed as an unenforceable penalty. Id. at 1115.

The Stipulated Judgment was unenforceable because it constituted an unenforceable penalty, not valid liquidated damages. “[A] court cannot enter a judgment that contains an unenforceable liquidated damages clause.” Id. at 1113. There was no meaningful relationship between the $28,970 amount of the Stipulated Judgment and the Castros’ failure to vacate by October 31, 2018 or to leave the vacated premises in broom-swept condition. In addition, the record did not show any effort by the parties to reasonably anticipate the amount of damages that might flow from a breach of the Stipulation. Similarly, nothing in the record showed the “the landlord’s chances to completely succeed at trial and recover all the unpaid rent allegedly owed.” Id. at 1118.

Graylee distinguished Jade Fashion & Co., Inc. v. Harkham Industries, Inc., 229 Cal.App.4th 635 (2014). In that case, the amount owed was undisputed, and the settlement was not an agreement to settle a disputed claim. Instead, the settlement was an agreement to forbear on the collection of a debt that was admittedly owed. Graylee, 52 Cal. App. 5th at 1117. In contrast, the Stipulation was a compromise of disputed claims, and the Castros never admitted that they owed $27,100 in unpaid rent. Id. at 1118.

In reversing and remanding, Graylee directed the trial court, among other things, to determine “whether the landlord suffered any actual damages as a result of the tenants’ breach of the stipulation.” Id. at 1119.

AUTHOR’S COMMENTS

Three takeaways from Graylee are: (1) a stipulated judgment that contains an invalid liquidated damages provision (or that results from an invalid liquidated damages provision in an underlying settlement) is not enforceable; (2) stipulated judgments and other settlements that provide for contingent reductions or increases in settlement payments must withstand a liquidated damages analysis, which should be made by the parties at the time of negotiating those payment contingencies, in the course of drafting the liquidated damages provision in the settlement; and (3) in determining whether a stipulated judgment or other settlement contains an unenforceable penalty, the court will be entitled to examine the underlying circumstances.

EDITOR’S COMMENTS

As a retired judge who has mediated many bankruptcy cases, both while active and in retirement, I find this holding by the California Court of Appeal troubling. A common way to settle pending litigation is an agreement for the defendant to pay a sum certain in installments. As an incentive for the defendant to perform, the agreement often has a provision that if the defendant defaults, after appropriate notice and opportunity to cure, a stipulated judgement for a sum greater than the installment sum will be entered, giving credit for any payments made. Under the reasoning ofGraylee, without more, such stipulated judgment would be found unenforceable as based on liquidated damages. One practice tip to avoid that consequence might be to structure the agreement to pay as a forbearance on collection of the greater amount (to be included in the Stipulated Judgment upon default). The Graylee court indirectly suggests this alternative by distinguishing the holding of Jade Fashion & Co v. Harkham Industries, Inc. by saying in that case the amount owed was undisputed and the agreement was a forbearance agreement. Perhaps my alternative will not work, however, where the amount owed is disputed, which is usually the case. The Court of Appeal implies that a party settling litigation with installment payments and forbearance must admit to the amount of damages before a stipulated judgment for a greater sum entered after default will be enforceable. Since almost all mediated settlements are premised on no admission of liability by the settling parties, if that admission is mandatory, this tool for settling cases may be disappearing.

These materials were written by Leonard L. Gumport of Gumport Law Firm, PC in Pasadena (lgumport@gumportlaw.com). Editorial contributions were provided by Meredith King of Higgs|Fletcher|Mack in San Diego (kingm@higgslaw.com) and the second edit and Editor’s Comment were provided by the Hon. Meredith Jury, retired Bankruptcy Judge and member of the ILC (majury470@gmail.com).

Best regards,

Insolvency Law Committee

Co-Chair
Michael W. Davis
DTO Law
mdavis@dtolaw.com

Co-Chair
Michael J. Gomez
Frandzel Robins Bloom & Csato, L.C.
mgomez@frandzel.com

Co-Vice Chair
Cathy Ta
Reorg Research, Inc.
cta@reorg.com

Co-Vice Chair
Christopher D. Hughes
Nossaman LLP
chughes@nossaman.com

Source: https://calawyers.org/section/business-law/