Where settlement agreement provides for a discounted principal amount to be paid in installments and the entire original liability becomes due because of a late payment, is default judgment for amount in excess an unenforceable penalty?

Posted in: Alternative Dispute Resolution, Contract Law by Steven Vartabedian on

In promissory note cases, it is not uncommon in my role as a mediator to assist parties in framing terms of a settlement that provides for installment payments. The creditor normally wants some “teeth” in the agreement in exchange for its promise to accept gradual payments rather than the full sum immediately upon settlement. On the other side, the debtor wants the benefit of a discounted principal as a reward for timely payment. This appears to be the scenario that was played out in Purcell v. Schweitzer (ordered published 3/17/2014) 2014 DJDAR 2387.

Plaintiff had received from defendant a promissory note for $85,000. Plaintiff sued defendant for default on the full sum. The parties reached a settlement agreement: plaintiff agreed to reduce the principal amount to $38,000, conditioned upon defendant’s payment of 24 timely monthly installment payments to include 8.5% interest; the full, discounted amount would be paid within these 24 months. The payments were due the first of each month; should a payment not be received by the fifth day of any month, the entire original liability of $85,000 would then become immediately due. The settlement agreement further provided that the late-payment provision was not a penalty, and that defendant waived any right to appeal and any right to contest or otherwise set aside a judgment.

Defendant paid the settlement note down to a balance of $1,776.58, then made a late payment of that balance, which was accepted by defendant. Asserting the late-payment clause of the settlement agreement, plaintiff filed this lawsuit and received a default judgment for $58,829.35, reflecting reinstatement of the original liability. Defendant’s motion to set aside this default judgment was granted, and plaintiff appealed. The Court of Appeal, Fourth Appellate District, Division One, affirmed, finding the default judgment was the result of an unlawful penalty or forfeiture.

The Court of Appeal recited the rule of enforceability of a liquidated damage clause: it must bear a reasonable relationship to the range of actual damages that the parties could have anticipated from the breach (Civil Code sections 1670 and 1671). Plaintiff argued that the settlement agreement here recited that the $85,000 was an agreed upon amount actually owed and was expressly stated as not being a penalty. However, the appellate court cited Greentree Financial Group Inc. v. Execute Sports, Inc. (2008) 163 Cal.App.4th 495, 499, for the proposition that the relevant breach here is the breach of the stipulation contained in the settlement agreement (in that case the stipulation for entry of judgment of installment payments of a lesser total sum than sought, which would be increased to the greater sum if not timely paid), not the breach of the underlying contract for which recovery was sought.

Plaintiff further argued that defendant here expressly waived the right to challenge the judgment. But the appellate court disagreed–the Civil Code sections cited set forth the public policy concerning liquidated damages which cannot be circumvented by words in the contract.

In my view, the facts of the instant case are particularly “bad” in that plaintiff accepted the full payment of the settlement payment a bit late, then sued for a substantial amount more. The case could have easily been decided as a matter of substantial performance/accord-and- satisfaction of the settlement agreement such that plaintiff would not be allowed to invoke the additional sum. However, the holding here is broader and suggests that when an installment settlement is reached, the creditor is not entitled to utilize an enforcement mechanism that would resurrect the original debt if it unreasonably exceeds the amount settled on. Thus the Purcell and Greentree opinions would appear to discourage installment settlements that allow the creditor restoration of the original principal amount if installments are not timely paid, and afford the debtor a discount for timely payments.

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