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Metlife Capital Financial Corporation v. Washington Avenue Associates, L.P.

313 N.J. Super. 525, 713 A.2d 527 (App. Div. 1998)

MORTGAGES; LOANS; LIQUIDATED DAMAGES—The court has rejected a fixed percentage late fee and an enhanced default rate in a mortgage loan as unenforceable penalties. Rent collected by a mortgagee pursuant to an assignment of leases must be applied against the loan reasonably contemporaneously with its collection.

A $1,500,000 mortgage on commercial property was to be repaid in 48 equal monthly payments with a balloon payment due at the end of the four-year term. The promissory note provided that “a late fee equal to the lessor of five percent (5%) of the delinquent payment or the highest late charge permitted by law shall be payable with respect to any payment which is not paid within ten (10) days of the date on which it was due.” It also provided that on a declaration of default, the interest rate on the unpaid principal balance would be an enhanced default rate equal to the greater of 5% per year in excess of the “prime rate” or 15% per year. The default rate could not exceed the maximum rate allowable under the law. In addition to payment of the late charge and the default interest rate, the mortgagor was also responsible, upon default, for “all costs of collection ... whether or not suit is filed.” Finally, as part of the loan documents, the mortgagor made a present assignment of rents due.

The defendant made all 48 pre-balloon payments, albeit 40 of them were made late. The record did not indicate how late each of the 40 payments was, but it suggested that many were made only a few days beyond the grace period. In any event, at the end of the four-year term, the mortgagor failed to make the balloon payment, whereupon the lender declared the note in default and began collecting rent pursuant to the assignment of rents. It also commenced a foreclosure action.

In the foreclosure action, the mortgagee challenged the lender’s calculation of the amount due, asserting that: (1) the contracted-for 5% late payment fee had been waived or, alternatively, it constituted an unenforceable penalty; (2) the default interest rate which amounted to 5.45% over the contract interest rate, constituted an unenforceable penalty; and (3) the lender failed to properly apply the rents it had received under the assignment of rents.

The Court found no conduct on the part of the lender that could reasonably support a contention that it had intentionally waived the late fee or that the borrower had relied on any such waiver. It did, find, considerable merit in the remainder of the mortgagor’s contentions.

With respect to application of the monies received pursuant to the assignment of rent, the lender’s apparent “tail-end” application of collected rents against the loan without a crediting of interest thereon was found to be in derogation of the lender’s contractual undertaking and in derogation of the implied covenant of good faith and fair dealing that inheres in every contract. Although under the terms of the loan documents, the lender was free to apply the rents in any order it chose, it was nevertheless obligated to apply them in some fair and reasonable manner. The Court did not believe that giving a credit in the accumulated amount of rent collected over a 10-month period without either having applied the rent against the borrower’s obligation as it was collected or crediting the borrower at some point with interest on the rents collected satisfied that obligation.

The Court then addressed the borrower’s argument that the 5% late fee was an unenforceable penalty and the lender’s counter-assertion that it is simply a reasonable liquidated damages clause. New Jersey follows the Restatement (Second) of Contracts sec. 356 (1) (1981) which provides that: “Damages for breach by either party may be liquidated in the agreement but only at an amount that is reasonable in 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.” The Court then asked a twofold question; first, whether the 5% late charge was reasonably related to the anticipated or actual damage likely to be suffered by the lender and, second, whether those damages are unascertainable or difficult to prove, resulting in the inconvenience or non-feasibility of otherwise obtaining a remedy. The Court was disturbed that the stipulated damages for breach of the borrower’s obligation to make timely monthly payments was expressed only in terms of a fixed percentage of the installment due without any reference to, or consideration of, the duration of the breach and without any reference to the amount of the late installment. The Court believed that in order for this particular late charge to constitute a reasonable stipulated damages provision as a matter of presumptive validity, the anticipated or actual damage suffered by the lender in the event of a late payment would have to be unrelated to the duration of the breach, and the anticipated or actual damages must have a material relationship to the amount of the installment since the amount of the late charge is a function only of the amount of the installment.

Testimony by the lender’s expert that the 5% late charge is the industry standard and custom was rejected by the Court. The lender’s expert also testified that the lender maintained an entire department with an internal procedure for handling delinquencies. She did not know of the actual costs incurred by the lender but did know that there were a lot them. The Court was willing to assume that the internal costs were reasonably recoupable and not merely a matter of the cost of doing business, but would not assume that they were necessarily related to the amount of the loan or to the installment. In its view, even though all borrowers who make a late payment would inflict the same amount of damages on a lender irrespective of the amount of the installment due, there was no reason why each borrower should pay a different stipulated damage depending only on the amount of the installment. It appeared to the Court that to the extent that administrative internal costs represent recoverable damages at all, a reasonable liquidated damage provision would have to be in the nature of a flat fee that would be the same for all borrowers. If, on the other hand, the duration and frequency of the delinquencies have a direct relationship to internal administrative costs, the uniform 5% fee still did not take these factors into account.

Furthermore, the Court found that to the extent that the late fee might be justified as compensation to the lender for the loss of the productivity of the loan, it was patent that the 5% late fee is wholly unsupportable and probably usurious. The same 5% is charged whether the installment is one day late or 30 days late. If it is one day late, the annualized interest rate would be 1,825%. In addition, if the late fee is to compensate the lender for loss of use of the money, the Court did not believe that such a loss was either unascertainable or difficult to prove. Consequently, the Court was persuaded that the 5% late charge failed to meet any liquidated damages tests. It also did not help that the Court believed that one of the purposes of the late charge was coercive, that is, to provide an incentive to the borrower, on payment incurring the late charge, to make timely payments. To reach its decision, the Court took notice of, but rejected, decisions in other jurisdictions that sustained a percentage late charge on the basis of industry custom or upon specific statutes within those jurisdictions.

With respect to the default interest rate, the Court started with the proposition that the extra 5.45% could be regarded as liquidated damages, rather than a penalty, only if it met the two-prong test previously described. The Court applied the same analysis to the default interest rate as it did to the percentage late fee, finding no reasonable support to sustain the default interest rate. What it said about the internal costs and the loss of the bargaining in connection with the 5% late charge applied to the default interest rate as well. As to other costs, the Court noted that attorney’s fees and other collection costs were already charged separately to the borrower and that the cost of obtaining appraisal and environmental reports was neither unascertainable nor difficult to calculate whether or not done in house. Once a Court determines that a liquidated damages provision constitutes a penalty, the party who attempts to impose that penalty is remitted to the ordinary recourse of proving actual damages sustained.

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