Filed 8/24/26 (see dissenting opinion)
CERTIFIED FOR PUBLICATION
IN THE COURT OF APPEAL OF THE STATE OF CALIFORNIA
SECOND APPELLATE DISTRICT
DIVISION EIGHT
LAKESHORE INVESTMENT LLC, B343435
Plaintiff and Respondent, (Los Angeles County
Super. Ct. No. 19STCV15381)
v.
NOW SOLUTIONS, INC, et al.,
Defendants and Appellants.
APPEAL from a post-judgment order of the Superior Court
of Los Angeles County, Tony L. Richardson, Judge. Reversed
with directions.
TencerSherman and Philip C. Tencer for Defendants and
Appellants.
Gilbert & Nguyen and Jonathan T. Nguyen for Plaintiff
and Respondent.
_____________________________
INTRODUCTION
This case addresses the enforceability of a liquidated
damages provision within a settlement agreement. Plaintiff
Lakeshore Investments (Lakeshore) and Defendants NOW
Solutions, Inc. and Vertical Computer Systems (together, NOW)
entered into an agreement to settle a lawsuit Lakeshore had
brought against NOW Solutions, Inc. The settlement agreement
provided that if defendants defaulted on their promise to pay
$450,000, they had to pay plaintiff $1.5 million as damages for
breaching the settlement agreement. Defendants failed to pay as
required. The trial court granted plaintiff’s application for an
order that defendants pay $1.5 million for the breach, plus
interest. On appeal, defendants argue the $1.5 million
represents an unenforceable penalty rather than plaintiff’s true
liquidated damages as required by law. We agree and reverse
the trial court’s order with directions to determine an amount
that represents plaintiff’s damages for the breach.
FACTUAL AND PROCEDURAL BACKGROUND
A. The Complaint
On January 9, 2013, plaintiff Lakeshore Investments
loaned $1,759,000 to NOW Solutions Inc. The loan was
documented in a promissory note with an interest rate of
11 percent, secured by an agreement pledging as collateral NOW
Solutions’s intellectual property. NOW Solutions defaulted on
the loan, leading to eight amendments to the payment schedule.
The last amendment dated December 11, 2017, added Vertical
Computer Systems (NOW Solutions’s parent company) as a co-
debtor and guarantor. This amendment set a monthly payment
at $31,564 and raised the default interest rate to 16 percent.
2
On May 2, 2019, Lakeshore filed a complaint alleging
defendants breached the promissory note and security agreement
by failing to remit the required monthly payments since January
2018. The complaint sought damages for breach of contract. The
prayer for relief sought general, consequential and special
damages; prejudgment interest from January 9, 2013, legal fees
and costs.
B. The Settlement Agreement
On November 3, 2023, counsel for the parties reported the
parties had entered into a written Settlement Agreement and
Mutual Release. Defendants agreed to pay plaintiff $450,000 in
three installments over a period of approximately 10 months.
The first installment of $30,000 was due on or before December 1,
2023; the second installment of $50,000 was due on or before
March 31, 2024; and the third installment of $370,000 was due
on or before September 30, 2024. (Plaintiff took on obligations as
well which it fully performed.) Defendants admitted no liability
with respect to the allegations of the complaint. All parties were
represented by counsel who reviewed and approved the
agreement as to form. The Settlement Agreement provided that
if defendants failed to timely pay an installment and failed to
cure the default within 10 business days of receiving a notice to
cure, plaintiff would be entitled to a stipulated judgment for
damages in the amount of $1.5 million plus interest at the legal
rate. The pertinent language of the Settlement Agreement for
our purposes is the following: “Defendants shall have ten (10)
business days from the date of e-mail notice to cure the default.
At any time after the tenth business day following the notice of
default, Plaintiff may notify the court of the default. In the event
Defendants default, and such default is not cured within ten (10)
3
business days, Defendants hereby agree and stipulate to the
entry of a judgment against them in the amount of $1,500,000
(one million, five hundred thousand dollars) to bear interest at
the legal rate.”
Defendants timely paid $80,000. They failed, however, to
pay the remaining balance due of $370,000 and failed to cure the
default after receiving the required notice.
C. Hearing and Entry of Judgment
On November 1, 2024, Plaintiff filed an ex parte application
for entry of default and default judgment. On November 5, 2024,
defendants filed written opposition to plaintiff’s application for
entry of default. Defendants argued the proposed judgment of
$1.5 million “is an unenforceable penalty because the amount
claimed bears no relationship to the damages Lakeshore could
have suffered resulting from failure to pay the original
settlement amount.” On November 6, 2024, the parties appeared
and argued the application for default and default judgment,
which the trial court granted. The court made no specific
findings in its judgment other than, “The Court is satisfied with
the supporting evidence demonstrating Defendants’ default on
October 1, 2024.” Defendants timely appealed.
DISCUSSION
On appeal, defendants argue the trial court erroneously
enforced the stipulated damages award of $1.5 million in the
settlement agreement, which constitutes an unlawful penalty
under California law. We agree.
4
A. Applicable Law
Civil Code section 1671, subdivision (b) provides: “[A]
provision in a contract liquidating the damages for the breach of
the contract 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.”
“A liquidated damages clause will generally be considered
unreasonable, and hence unenforceable under [Civil Code] section
1671[, subdivision] (b), if it bears no reasonable relationship to
the range of actual damages that the parties could have
anticipated would flow from a breach. The amount set as
liquidated damages ‘must represent the result of a reasonable
endeavor by the parties to estimate a fair average compensation
for any loss that may be sustained.’ [Citation] In the absence of
such relationship, a contractual clause purporting to
predetermine damages ‘must be construed as a penalty.’ ”
(Ridgley v. Topa Thrift & Loan Assn. (1998) 17 Cal.4th 970, 977
(Ridgley); Morris v. Redwood Empire Bancorp (2005)
128 Cal.App.4th 1305, 1314; Greentree Financial Group, Inc. v.
Execute Sports, Inc. (2008) 163 Cal.App.4th 495, 499 (Greentree
Financial).) The “amount of the judgment must reasonably
relate to the damages likely to arise from the breach of the
stipulation, not the alleged breach of the underlying contract,
because it is the breach of the stipulation that allows” judgment
to be entered against the defaulting party. (Vitatech Internat.,
Inc. v. Sporn (2017) 16 Cal.App.5th 796, 810 (Vitatech); Greentree
Financial, at p. 499 [the relevant breach to be analyzed is the
breach of the stipulation, not the breach of the underlying
contract].)
5
When a stipulated judgment amount is not reasonably
related to damages arising solely from the failure to pay the
stipulated judgment, it constitutes an unenforceable penalty.
(Purcell v. Schweitzer (2014) 224 Cal.App.4th 969, 974 (Purcell).)
B. Standard of Review
Whether “the amount to be paid upon breach of a
contractual term should be treated as liquidated damages or as
an unenforceable penalty is a question of law, which we review de
novo.” (Greentree Financial, supra, 163 Cal.App.4th at p. 499.)
We note one recent decision has determined that because
resolution of whether the liquidated damages provision is an
unenforceable penalty may depend on factual determinations, the
question is more appropriately reviewed under the substantial
evidence standard, and it becomes a question of law only when
undisputed facts support a single reasonable conclusion.
(Krechuniak v. Noorzoy (2017) 11 Cal.App.5th 713, 722–724.)
There are no disputed facts in the record here so we apply the de
novo standard of review.
C. Analysis
The burden of showing that the liquidated damages
provision is invalid in this case falls on defendants NOW. The
record contains no facts describing the circumstances existing at
the time the settlement agreement was negotiated, other than
the existence of the underlying breach of contract action and a
statement that the parties arrived at their agreement “following
extensive good faith negotiations.” Defendants argue that the
$1.5 million liquidated damages provision is not reasonable
because it is three times the amount they owed under the
settlement agreement and therefore bears no reasonable
6
relationship to the range of actual damages that the parties could
have anticipated would flow from a breach.
We conclude the $1.5 million default payment amount is a
penalty, not an enforceable liquidated damages provision. The
record lacks facts establishing that the amount set as liquidated
damages ($1.5 million) represents “ ‘the result of a reasonable
endeavor by the parties to estimate a fair average compensation
for any loss that may be sustained.’ ” (Ridgley, supra, 17 Cal.4th
at p. 977.) Plaintiff argues the stipulated judgment was intended
to account for its broader damages, including defendants’ poor
history of making payments since 2013; defendants’ financial
condition at the time of the settlement; the costs of the protracted
litigation since the filing of the complaint in May 2019; and the
risk in actually collecting a trial judgment. The default term
represents a reasonable estimate of a compromised amount
moving forward.
Nevertheless, as plaintiff concedes, “there is no
demonstrable evidence that these factors were considered, by
both sides, in the settlement discussions.” On this record, we
decline to presume that such discussions occurred.
We acknowledge that defendants bear the burden of
showing that the amount of $1.5 million in liquidated damages is
unreasonable because it bears no reasonable relationship to the
range of actual damages that the parties could have anticipated
would flow from a breach. It is not plaintiffs’ burden to show the
amount is reasonable. We conclude that defendants have met
their burden by the fact that the $1.5 million is three times the
amount of the money due under the settlement agreement. We
cannot conceive of actual damages of $1.5 million for breach of
this agreement.
7
What some might label a “per se unreasonable proportion”
approach in the absence of other evidence of reasonableness is
supported by caselaw. In Vitatech, the court found that the
stipulated judgment for more than four times the amount
Vitatech agreed to accept as full settlement of its claims was an
unenforceable penalty as a matter of law where there was no
reasonable relationship between the $75,000 settlement amount
and the stipulated judgment for more than $300,000. (Vitatech,
supra, 16 Cal.App.5th at pp. 800–801.) There, as here,
defendants never admitted liability on the underlying claims or
the amount of damages allegedly caused by the breach of the
underlying contract, and no facts were presented as to the
circumstances existing between the parties at the time the
parties executed their agreement. (Id. at pp. 810–814.)
Similarly, in Greentree Financial, plaintiff brought an
action for breach of contract, alleging a failure to pay $45,000
under the contract. (Greentree Financial, supra, 163 Cal.App.4th
at p. 498.) The parties settled the action for a total of $20,000 in
two installments. (Ibid.) If defendant defaulted, the amount due
was the full amount prayed for in the complaint. (Ibid.) The
defendant defaulted on the first installment payment of $15,000.
(Ibid.)
In finding that the stipulated judgment was an
unenforceable penalty, the Court of Appeal noted the absence of
facts showing a reasonable relationship to the range of actual
damages that the parties could have anticipated would flow from
the breach. (Greentree Financial, supra, 163 Cal.App.4th at
pp. 499–500.) There, like here, no facts illuminated how or why
the parties arrived at the liquidated damages amount. The Court
of Appeal noted that the parties simply selected the amount
8
plaintiff had claimed in the underlying lawsuit. This presented a
problem because the record showed nothing about the plaintiff’s
chances of complete success on the merits of its case. (Ibid.) As
is the case here, the record in Greentree Financial included only
the complaint and the answer thereto. (Id. at p. 500.) Greentree
Financial’s record also included an express disclaimer of liability
by each party; here we have a similar absence of admissions of
liability. (Ibid.) The Greentree Financial court speculated that
the lack of a guarantee of success at trial “may explain” why the
plaintiff was willing to accept less than half the amount
demanded in the complaint. (Ibid.) It went on to comment that in
the absence of a reasonable relationship between the liquidated
damages provision and actual anticipated damages for breach of
the settlement agreement, the stipulated judgment of more than
triple the amount of the settlement was void. (Id. at pp. 500–
501.)
Likewise, in Purcell, the plaintiff, who had settled for
$38,000, simply argued that the $85,000 liquidated damage
amount reflected the economics associated with “proceeding
further” with the lawsuit. (Purcell, supra, 224 Cal.App.4th at
p. 976.) The court rejected that approach, finding “There is
nothing in the record to support the fact that obtaining a
judgment and instituting postjudgment procedures would cost
$85,000.” (Id. at p. 976.)
As a second basis for our decision, $1.5 million, on its face,
bears no reasonable relationship to the range of actual damages
the parties could have anticipated from a breach of the
stipulation to settle the dispute for $450,000. As Greentree
Financial noted, damages for the withholding of money are easily
determinable—i.e., interest at the prevailing rates. (Greentree
9
Financial, supra, 163 Cal.App.4th at p. 500.) Plaintiff asks us to
compare the damages sought in the original complaint
($1,759,150 plus attorney fees, costs and interest) to the $1.5
million default assessment and conclude that the $1.5 million
judgment was appropriate. The caselaw cited above rejects using
the damage amount of the original complaint as any sort of
yardstick by which to measure damages from breach of the
settlement agreement.
Next, the stipulated judgment of $1.5 million would result
in an additional assessment of approximately $1 million more
than the total due under the settlement agreement. This
differential of $1 million fails “to take into account the need for
proportion in damages—the critical item in evaluating penalty
and forfeiture.” (Sybron Corp. v. Clark Hosp. Supply Corp. (1978)
76 Cal.App.3d 896, 903.) We conclude it is clearly a penalty
rather than a reasonable estimate of damage plaintiff could have
sustained by defendants’ breach.
D. Plaintiff’s Remaining Arguments
We note that notwithstanding the 1977 amendments to
Civil Code sections 1670 and 1671, courts have steadfastly held
that although the Legislature moved the burden of proof to the
party challenging a damages provision, the “amendment of the
statute does not save a judgment that imposes a penalty bearing
no proportional relationship to the damages that might actually
flow from a breach.” (Greentree Financial, supra,
163 Cal.App.4th at p. 501, fn. 2, citing Ridgley, supra, 17 Cal.4th
at pp. 976–977.)
Plaintiff argues that defendants were represented by
counsel and cannot, therefore, claim they did not understand the
settlement agreement’s terms. Defendants, however, do not
10
contend that they misunderstood the terms of the settlement
agreement.
Plaintiff next contends that under California law,
represented parties who knowingly stipulate to settlement terms
cannot set aside the agreement when one party has already fully
performed its obligation, absent evidence of fraud,
misrepresentation, or unconscionability. In support of this
contention, plaintiff cites In re Marriage of Friedman (2002)
100 Cal.App.4th 65 (Friedman) and In re Marriage of Egedi
(2001) 88 Cal.App.4th 17 (Egedi). Plaintiff argues these cases
collectively support the notion that stipulated settlement
agreements, particularly those where, as here, one party has fully
performed, should not be set aside absent compelling equitable
considerations, as doing so would undermine fairness and public
policy favoring settlements.
Friedman is inapt. It acknowledges that a theoretical and
unrealized conflict of interest between husband and wife did not
warrant setting aside a postnuptial agreement. Because there
was no evidence of fraud, compulsion, actual conflict of interest,
illegal purpose or attempted fraudulent conveyance, the
agreement could be enforced there. (Friedman, supra,
100 Cal.App.4th at pp. 72–73.) Those factors, however, are not
the universe of reasons undermining enforcement of a contractual
agreement.
Egedi actually supports defendants’ position. It
acknowledges the trial court has the power to invalidate a
marital settlement if it is inequitable, even though not induced
through fraud or compulsion. (Egedi, supra, 88 Cal.App.4th at
pp. 22–23.) Here, a liquidated damages provision lacking a
reasonable relationship to the range of damages the parties
11
reasonably could have anticipated is unenforceable and void as
against public policy, regardless of the presence or absence of
fraud or compulsion. (Vitatech, supra, 16 Cal.App.5th at p. 807.)
Plaintiff also cites Rheinhart v. Nissan North America, Inc.
(2023) 92 Cal.App.5th 1016 for the proposition that California
has a strong public policy favoring the voluntary settlement of
disputes. (Id. at p. 1027.) This is so. Rheinhart acknowledges,
however, that “Notwithstanding that policy, courts can declare
settlement agreements and releases, which the law treats like
any other contracts [citation], void and unenforceable on the
basis of other public policies, illegality or unfairness.” (Ibid.)
Finally, plaintiff argues that Code of Civil Procedure
section 664.6 does not empower a trial court to modify or alter the
terms of a settlement agreement. Plaintiff fails to acknowledge
that section 664.6 explicitly provides that the court may enforce
the settlement as agreed upon by the parties, but it is not
compelled to do so just because the parties agreed upon the
terms.
As for the comments in the dissent, we remain faithful to
the analysis of the California Supreme Court in Ridgley: “A
liquidated damages clause will generally be considered
unreasonable, and hence unenforceable under [Civil Code] section
1671[, subdivision] (b), if it bears no reasonable relationship to
the range of actual damages that the parties could have
anticipated would flow from a breach. The amount set as
liquidated damages ‘must represent the result of a reasonable
endeavor by the parties to estimate a fair average compensation
for any loss that may be sustained.’ [Citation.] In the absence of
such relationship, a contractual clause purporting to
predetermine damages ‘must be construed as a penalty.’ ”
12
(Ridgley, supra, 17 Cal.4th at p. 977.) The record here lacks facts
to establish that $1.5 million represents the range of actual
damages the parties anticipated would flow from a failure to pay
$370,000. Defendants’ position was that liquidated damages of
over $1 million per se bore no reasonable relationship to any
possible range of damages for breach. We agree with defendants
that such a disparity is a penalty and we find their position is
supported by the approaches taken by Ridgely, Vitatech, and
Greentree Financial.
We also note Gormley v. Gonzalez (2022) 84 Cal.App.5th 72,
relied upon by the dissent, held that plaintiffs’ presentation of
the dynamics and considerations that resulted in the liquidated
damages provision at issue there established a reasonable
relationship between the liquidated damages and a fair average
compensation for any loss that might have been sustained by the
breach of the agreement. In light of the facts plaintiffs presented,
the court found defendants, who “submitted no evidence of their
own,” had failed to “establish the liquidated damages provision
was unreasonable and thus invalid.” (Id. at p. 78.)
Here we have no evidence from any party, other than the
over $1 million owed for breaching the agreement. In the interest
of justice, we send the matter back to the trial court to take
whatever evidence the parties seek to present so that the trial
court may calculate a fair average compensation for defendants’
breach.
Defendants do not escape unscathed from their obligations
under the settlement agreement. They remain liable for the
actual damages resulting from their default. The lender’s
charges could be fairly measured by the period of time the money
was wrongfully withheld plus the administrative costs reasonably
13
related to collecting and accounting for late payment. (Garrett v.
Coast & Southern Fed. Sav. & Loan Assn (1973) 9 Cal.3d 731,
741 & fn. 11 [damages from the wrongful withholding of money
are fixed by law (Civ. Code, § 3302) and other damages resulting
because of a borrower’s default on an installment, such as
administrative and accounting costs, would not appear to present
extreme difficulty in prospective fixing].) We direct the trial
court on remand to conduct a hearing to fix the actual damages
caused by defendants’ breach of the settlement agreement.
DISPOSITION
The trial court’s order is reversed with directions on
remand to determine reasonable actual damages caused by
defendants’ breach of the settlement agreement. Costs are
awarded to defendants.
CERTIFIED FOR PUBLICATION
STRATTON, P. J.
I concur:
VIRAMONTES, J.
14
Wiley, J. dissenting.
The majority opinion has five problems.
1. It misapplies the statute.
2. It conflicts with recent judicial precedent.
3. It is illogical.
4. It is unfair.
5. It will be economically destructive.
I
The majority does injustice to the statute, which is clear as
a bell. The statute says “a provision in a contract liquidating the
damages for the breach of the contract 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.” (Civ. Code §1671, subd. (b), italics
added; (“§1671(b)”).)
Let’s go through this bit by bit.
Who is the party seeking to invalidate the provision? That
would be defendant and appellant NOW Solutions, Inc., which is
a subsidiary of parent corporation and codefendant and appellant
Vertical Computer, Inc. Vertical was a publicly traded
corporation under the ticker symbol VCSY. For convenience, I
refer to these affiliated corporations under the single word
Vertical.
How does the statute want us to determine “the
circumstances existing at the time the contract was made”
(§1671(b), italics added)? A factual presentation would be
essential to determine “the circumstances.” (Ibid.) When we ask,
“what were the circumstances?” we are asking “what were the
facts?” This is plain English.
1
The statute thus required Vertical to supply a factual
showing if it wanted to “invalidate” the liquidated damages
provision to which it agreed. (§1671(b).)
Problem number one: Vertical offered no relevant facts. It
supplied one declaration by its attorney Ryan Nell that purported
to authenticate some documents. This declaration did not
otherwise address “the circumstances existing at the time the
contract was made.” (§1671(b), italics added.)
In short, Vertical offered no relevant evidence. Because the
party seeking to invalidate the provision had the burden but
offered no facts about the circumstances, the liquidated damages
provision is “valid.” (§1671(b).)
If we attend to the statute, this case is open and shut.
The statute also explains why Ridgley v. Topa Thrift &
Loan Assn. (1998) 17 Cal.4th 970 (Ridgley) is different from this
case.
The statute draws a fundamental distinction between
business-to-business deals and consumer cases. When the
Legislature amended this statute in 1977, it created “a new
general rule favoring the enforcement of liquidated damages
provisions except against a consumer in a consumer case. In a
consumer case, the prior law under former Sections 1670 and
1671, continued in subdivision (d), still applies.” (Cal. Law
Revision Commission com., foll. § 1671, italics added; see Zengen,
Inc. v. Comerica Bank (2007) 41 Cal.4th 239, 252 [Commission’s
comments are persuasive evidence of the legislative intent].)
The logic of this statutory distinction is plain because the
distinction makes sensible generalizations. Consumers rarely
retain counsel when taking out a home loan or the like, and the
contract they sign usually is something their lender gives them
2
on a form. The situation generally is different in the business-to-
business deal, where sophisticated parties have equal access to
legal advice and can negotiate a contract on a fully informed
basis. Whatever concerns about the fairness of contract
formation that might exist in the consumer situation vanish
when one business deals with another on an equal footing.
Ridgley was a consumer case, which the statute treats
differently. The loan there was a home loan Topa Thrift & Loan
Association made to a married couple named the Ridgleys. The
transaction was bank-to-consumer and not business-to-business.
The liquidated damages clause was in Topa’s preprinted form.
The Ridgleys were not represented by counsel. (Ridgley, supra,
17 Cal.4th at pp. 974–975.)
This case is unlike Ridgley, and the statute states the
consumer/non-consumer distinction that proves it. In this
statutory case, the words of the statute should be paramount.
They dictate affirmance.
II
The majority opinion conflicts with the most recent and
authoritative case: Gormley v. Gonzalez (2022) 84 Cal.App.5th
72, 89 (Gormley).) Gormley enforced a liquidated damages clause
like this one. Gormley’s thoughtful reasoning should govern.
Gormley involved a lawsuit settlement in which the
defendant promised to pay the plaintiffs $575,000. “As incentive
to pay the installments as agreed to, the liquidated damages
terms were agreed upon.” (Gormley, supra, 84 Cal.App.5th at p.
78.) That was the situation here.
The settlement agreement in Gormley capped liquidated
damages at $1.5 million and keyed the exact amount to how
much of the debt the defendants had paid. When the defendants
3
failed to pay as they had promised, the plaintiffs moved under
Code of Civil Procedure section 664.6 “to enforce the settlement
agreement, including the liquidated damages provision.”
(Gormley, supra, 84 Cal.App.5th at p. 76.) The defendants
protested, but—as here—offered no evidence. (Id. at p. 78.) The
trial court enforced the liquidated damages provision and entered
judgment as the plaintiffs requested in the sum of $1,393,084.
The Court of Appeal affirmed this judgment over the defendants’
§1671(b) protest. (Gormley, supra, 84 Cal.App.5th at p. 76.)
Gormley is recent and squarely on point. This thorough
and sound opinion distinguished Ridgley and explained why the
lower court decisions on which the majority relies were
incorrectly decided. (Gormley, supra, 84 Cal.App.5th at pp. 79–
89.)
Gormley likewise explained it is proper to compare the
liquidated damages number to the sum the underlying case
sought and not to the discount for which the underlying case
settled. (Gormley, supra, 84 Cal.App.5th at pp. 86–87.) “We find
nothing unreasonable about parties (particularly represented
parties) agreeing to settle a lawsuit for a steep discount, and also
agreeing that if the settlement amount is not paid, judgment will
be entered on the amount the parties estimated would have been
recovered at trial.” (Id. at p. 87, italics added.)
Applying Gormley to this case shows errors in the
majority’s reasoning. The amount the parties estimated would
have been recovered at trial would have dwarfed the $1.5 million
figure. We see this by looking at what Lakeshore was seeking in
its underlying lawsuit to recover the mounting debt on its loan to
Vertical.
4
Vertical and Lakeshore agreed the liquidated damages
were $1.5 million. Lakeshore’s underlying case, filed May 2,
2019, sought damages “in a sum to be determined at the time of
trial.” At that time, the complaint alleged Vertical owed
Lakeshore a current principal balance of $2,261,324.60. The
interest on this unpaid sum was ticking upwards at $1,071.87 a
day.
Using Gormley’s proper method—compare the liquidated
damage sum to the amount sought at trial—shows this trial court
was right to hold Vertical to its deal. The liquidated damages
were $1.5 million—in 2019. The amount Lakeshore sought at
trial was, as just stated, $2,261,324.60—in 2019. With interest
at $1,071.87 a day, that sum ballooned to $4,421,142.65 on the
date when the trial court signed the order under review, which
was November 6, 2024. (This figure is simple arithmetic: count
the days and multiply by the daily amount.) And the lost interest
caused by Vertical’s delay in payment has inexorably ticked
upwards every day since then. Compared to $4.4 million, $1.5
million was reasonable.
The familiar rule is that we imply findings to support the
judgment. This judgment was sound. We should support it.
According to Gormley, then, the majority errs by comparing
$1.5 million to a mere $450,000, which was the “steep discount”
at which Lakeshore finally decided to settle this case. (Gormley,
supra, 84 Cal.App.5th at p. 87.)
III
The majority result is illogical. It offers a paternalistic
hand to a deadbeat corporation to get it out of the bed it made for
itself. The corporation’s lawyers helped it make the bed. Why on
earth help this party?
5
As Judge Posner dryly remarked, “[T]he refusal to enforce
penalty clauses is (at best) paternalistic—and it seems odd that
courts should display parental solicitude for large corporations.”
(Lake River Corp. v. Carborundum Co. (7th Cir. 1985) 769 F.2d
1284, 1289 (Lake River).)
The scholarly literature has been hard on the approach the
majority takes, and on precisely Judge Posner’s ground: when
corporate lawyers guided a corporate client in making its solemn
and considered commitment, why help that corporation break its
promise?
As Gormley explained, California revised its statute in
1977. (See Gormley, supra, 84 Cal.App.5th at p. 80.)
In 1977 it was becoming plain the intellectual foundation
for the old law was rotten. The better rule, the sound and usual
rule, is to enforce contracts as they are written when
sophisticated parties represented by counsel drafted the
document. Doing otherwise invites socially destructive mischief.
In 1972, Stanford Professor John H. Barton explained “that
in evaluating the enforceability of a liquidated damages clause a
court should inquire not into the uncertainty of estimating
damages beforehand or the consistency of the clause with the
traditional law of damages, but only whether the provision was
knowledgeably and fairly bargained for. I do not deny that the
test classically used to distinguish an imposed ‘penal damage’
clause (which will not be enforced) from a negotiated ‘liquidated
damage’ clause (which will be enforced) may be useful evidence of
the fairness of the bargaining. It is clear, however, that courts
are acting improperly in ignoring a liquidated damage clause if
their ground is that the parties are setting their own law.
Liquidated damage clauses can reasonably be rejected only on a
6
basis that the negotiation (or its reduction to writing) was unfair
in some way.” (Barton The Economic Basis of Damages for
Breach of Contract (1972) 1 J. Legal Studies 277, 286–287.)
In 1977, a similar analysis concluded that “many people
may not want to make deals unless they can shift to others the
risk that they will suffer idiosyncratic harm or otherwise
uncompensated damages. To the extent that the law altogether
prevents such shifts from being made or reduces their number by
unnecessarily high costs, it creates efficiency losses; that is, it
prevents some welfare increasing deals from being achieved.”
(Goetz & Scott Liquidated Damages, Penalties and the Just
Compensation Principle: Some Notes on an Enforcement Model
and a Theory of Efficient Contract Remedy (1977) 77 Columbia
Law Review 554, 583.)
On the wave of this scholarship, the Legislature revised the
governing statute in 1977. This scholarship informs our state
statute.
Judge Posner summarized this scholarship by observing
that “the parties (always assuming they are fully competent) will,
in deciding whether to include a penalty clause in their contract,
weigh the gains against the costs—costs that include the
possibility of discouraging an efficient breach somewhere down
the road—and will include the clause only if the benefits exceed
those costs as well as all other costs.” (Lake River, supra, 769
F.2d at p. 1289.)
As the statute directs, when sophisticated corporations
aided by counsel negotiate a contract, courts should enforce it by
its terms unless the complaining party can explain how the
negotiation process was unfair. Vertical offered no evidence of
this kind. There was no form contract: the words were
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negotiated with the aid of counsel. This is plain from the 10-page
settlement agreement itself. Respondent Lakeshore Investment
LLC properly put this settlement agreement into evidence in the
trial court. Vertical never objected to this evidence, and offered
no evidence of its own. During contract negotiations with
Lakeshore, Vertical had full access to its team of corporate
attorneys.
So when a publicly traded corporation represented by
lawyers in a fair bargaining process agreed it was reasonable to
set its liquidated damages at $1.5 million, why are we
disagreeing? Where is the logic in that?
The majority does not attempt to explain the logic of its
holding. Why would the California Legislature write a law to
help a corporation like Vertical, with all its lawyers, to break its
promise on repaying its debt? What public policy could that
possibly serve?
IV
The majority result is unfair. Vertical owed money to
Lakeshore and, to get forbearance, promised to pay liquidated
damages in the event of default. Now Vertical is claiming what it
offered is invalid. This is a “hey neener neener, gotcha sucker”
defense. (Gormley, supra, 84 Cal.App.5th at p. 89.) This
opportunistic trickery is unfair.
Recall Lakeshore alleged, without contradiction in the
record, that it made this $1,759,150.00 loan to Vertical in 2013.
Lakeshore has been trying for 13 years to collect this debt. But
13 years is not enough delay. Today the majority remands for
further proceedings—further delays, further attorney fees,
further costs, further lost interest. The unfairness is acute.
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The majority does not attempt to portray this result as fair.
This is because it cannot.
V
The majority result will be economically destructive.
Lenders in the future will be more reluctant to help
corporate borrowers in their times of need if lenders cannot
enforce their arm’s length deals according to the negotiated
terms. Denying enforcement of the deal as written will create
harmful effects: fewer loans, or loans at higher rates.
Liquidated damage clauses perform a valuable economic
function. Judge Posner gives pertinent examples. “Suppose I
know that I will honor my contracts, but I find it difficult to
convince others of this fact. By signing a penalty clause I
communicate credible information about my own estimate of my
reliability—information useful in determining on what terms to
do business with me. ¶ Another reason for a penalty clause is to
compensate the seller for a high risk of default. Suppose
defaulting buyers will often be insolvent or otherwise unable to
cover the seller’s full damages. Then the ‘windfall’ recovery of a
penalty in some cases will, by offsetting losses incurred in others,
enable sellers to take greater risks and charge lower prices.”
(Posner, Economic Analysis of Law (9th ed. 2014) pp. 140–141,
italics added.)
Liquidated damages clauses thus enable private parties to
strike agreements beneficial to the wider economy and to our
society as a whole, which depends on private ordering for its
material wellbeing. Refusing to enforce those agreements as they
are written will harmfully reduce these benefits.
Imagine you ran a business with a cash flow problem and
you were seeking a loan to keep you going until expected
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revenues arrived. If your prospective lender reads the majority
opinion, the effect would be to make the lender less willing to
loan you funds at a favorable rate. The majority opinion will
make business loans riskier and thus more expensive, because a
deal is no longer a deal but instead a lawsuit. In the long run,
increasing risk and the cost of credit is harmful. It helps no one.
+ + + + + + +
I dissent because, by misapplying the statute and departing
from recent precedent, the majority reaches a result at once
illogical, unfair, and destructive. I respect and admire my dear
colleagues, and for these reasons view their decision with
puzzlement and dismay. I recommend Lakeshore seek further
review.
WILEY, J.
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