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MetLife Capital Financial Corp. v. Washington Avenue Associates

159 N.J. 484, 732 A.2d 493 (1999)

MORTGAGES; LOANS; LIQUIDATED DAMAGES—A five percent late fee and a five percent increase in the loan rate upon default are presumptively reasonable liquidated damages for commercial loans.

A borrower executed a four-year promissory note to its lender, secured by real property. The note provided for equal monthly payments and a final balloon payment at the end of the term. It also provided for a late fee equal to the lesser of 5% of each delinquent payment or the highest late charge permitted by law on any payment not made within ten days of the due date. In addition to the late fee, the note provided for a default rate, which was defined as the greater of 5% per year in excess of the prime rate of a designated bank or 15% per year, not to exceed the maximum rate under law. The borrower made all 48 payments, but 40 of them were delinquent. It failed to make the balloon payment at maturity. The lender declared the loan in default and began to collect rents directly from the property’s tenants. In the foreclosure action that followed, it claimed the late fee and the enhanced (default) interest rate. The Appellate Division concluded that both the 5% late fee and the enhanced (default) interest rate constituted unenforceable penalties and also ordered that the lender apply the rents it collected on a reasonably contemporaneous basis. The Supreme Court disagreed with the Appellate Division in its characterization of the 5% late charge and the enhanced interest rate as unenforceable penalties, holding instead that each was a reasonable liquidated damage for the borrower’s default on the commercial mortgage. In doing so, it held that liquidated damages in a commercial contract between sophisticated parties are presumptively reasonable and the party challenging the clause bears the burden of proving its unreasonableness. In holding that the 5% late fee was a valid measure for liquidated damages, it found that it was appropriate to assess the reasonableness of late charges by looking at what is permitted by statute in similar circumstances and what constitutes common practice in a competitive industry. In addition, it held that default interest rates, like late fees, are presumed reasonable, but a default provision providing for an unreasonable increase in the contract interest rate could be found unenforceable as a penalty. Under the particular facts, the actual default rate (12.55%) was held to be a reasonable estimate of the potential cost of administering this particular defaulted loan and the potential difference between the contract interest rate and the rate that the lender might pay to secure a commercial loan replacing the lost funds. The Supreme Court did agree with the Appellate Division in its analysis of the way in which the lender had misapplied the rents. In its view, although an absolute assignments of rents provision passes title to the rents to the assignee upon default, the assignee may not deny the party in default an accounting of rents collected and also must deduct an allowance for the rents from the amount due on the mortgage in a reasonably prompt fashion. In essence, the Court held that late charges and default interest provisions constitute a practical solution to the problem of pricing loans according to anticipated rather than actual performance and the difficulty in allocating and determinating the cost in damages for late payments and defaults. Moreover, considerations of judicial economy and freedom of contract favor enforcement of stipulated damages clauses.


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