The following is a case update written by the Hon. Meredith Jury (U.S. Bankruptcy Judge, C.D. CA., Ret.), analyzing a recent decision of interest:
Distinguishing this case from recent California appellate cases which declined to enforce liquidated damages clauses in settlement agreements as being in violation of California Civil Code § 1671, the California Court of Appeal (the Court) upheld the liquidated damages provision in a negotiated settlement agreement because the appellants failed to present affirmative evidence that the “provision was unreasonable under the circumstances.” Gormley v. Gonzalez, 84 Cal. App. 5th 72 (2022).
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Plaintiffs/appellees were involved in twenty separate lawsuits arising out of medical care provided to them by defendants/appellants. The total damages alleged in the multiple lawsuits exceeded $1.5 million and defendants conceded that plaintiffs would likely have been awarded at least that sum had the lawsuits proceeded to trial. Although defendants carried some malpractice insurance, only six of the twenty cases fell within its coverage, plus the policy was a “burning policy” such that it was diminished by attorneys’ fees and costs incurred in defense of the claims. Prior to trial in the consolidated cases, the parties entered into a global settlement agreement (the Settlement Agreement) which provided that defendants would pay a total sum of $575,000, payable in two installments, one for $250,000 due soon after the agreement was executed and the second for $325,000 due ninety days thereafter. The Settlement Agreement further provided that if the payments were not made in full, liquidated damages would be assessed at $50,000 per month ($1644 per day), with a cap of $1.5 million.
Defendants failed to pay any of the agreed funds. Plaintiffs brought a motion to enforce the Settlement Agreement and a second motion which asked the trial court to determine the validity of the liquidated damages provision. The motions were supported by a declaration from plaintiffs’ attorney, who stated that both sides were represented by counsel when they negotiated the Settlement Agreement and that several drafts of the agreement had been exchanged. He also declared that plaintiffs had agreed to a substantial discount in the value of their claims in order to receive prompt payment and that all parties agreed that a reasonable estimate of the total verdicts was $1.5 million. Defendants opposed the motions but submitted no evidence of their own, arguing that the liquidated damages provision was unenforceable as a matter of law under Civil Code § 1671.
The trial court granted the motions, enforcing the agreement and assessing the liquidated damages, resulting in an award to plaintiffs of almost $1.4 million, which included $818,084 in liquidated damages. Defendants appealed to the Court, which affirmed.
California statutes have controlled the enforceability of liquidated damages clauses since 1872. A prior version of § 1671 stated that a liquidated damages provision was valid only “when, from the nature of the case, it would be impracticable or extremely difficult to fix the actual damages.” As interpreted by the courts, this statute created a presumption that the clauses were void unless the impracticability of measuring actual damages was supported by affirmative evidence. In 1977 the Legislature adopted a California Law Revision Commission (the Commission) recommendation which amended § 1671 by adopting subdivision (b) which applied only to non-consumer contracts where the parties had relatively equal bargaining positions. The new subsection shifted the burden, finding the clauses presumptively valid unless a party affirmatively presented evidence that the liquidated damages provision was not reasonable taking into account all relevant considerations. Otherwise, the provisions of § 1671 were unchanged when applied to consumer contracts. The Commission’s stated intent, adopted by the Legislature, was to ‘reverse the basic disapproval of liquidated damages provisions expressed [in the statutes]…and in the judicial decisions…. and to reverse the burden of proof on the issue of reasonableness” such that it was on the party seeking to invalidate the provision.
Appellees argued that the trial court’s decision ran counter to two cases which invalidated the equivalent of liquidated damages clauses in settlement agreements, Greentree Financial Group, Inc v Execute Sports, Inc., 163 Cal. App. 5th 495 (2008) and Vivatech Internat., Inc. v Sporn, 16 Cal. App. 5th 796 (2017). In both cases, the Court of Appeal had struck provisions in settlement agreements which called for a substantially enhanced judgment if defendants defaulted in paying an agreed lesser sum timely. The Court rejected those cases as precedent because both used the test in § 1671 which applied to consumer contracts with uneven bargaining positions, not agreements such as the one here which was negotiated by competent counsel with many drafts and concessions on both sides. In addition, the plaintiffs here had presented evidence that the clause was inserted to incentivize prompt payment and capped the damages at a sum that defendants agreed was the likely amount to be awarded should the matters proceed to trial. The Court found the lower court had properly considered “all circumstances” as compelled by Commission comments when finding the clause reasonable.
The Court also distinguished other California authority which had invalided a late fee provision as unreasonable where it had no bearing on the actual damages caused by a late payment on a loan. Pertinent to the Court’s ruling here was the admission by defendants that the likely damages would be $1.5 million.
The enforcement of liquidated damages clauses, including escalated judgments which might result from default in installment payments in a settlement agreement, has been much litigated in California. The interpretation of Civil Code § 1671 and its applicability to the facts of each particular matter is usually the lynchpin in a court’s analysis. This case is significant because where an agreement had been negotiated by able counsel and had gone through several drafts, the Court upheld the larger judgment, relying on the shift in the burden of proof. In addition, the admission by defendants that the greater sum represented the likely damages which could be awarded sealed the deal with regard to enforceability. In many settlement agreements, defendants do not agree the plaintiffs’ prayer is a reasonable assessment of likely damages; that admission here was unique.
The practice tip is obvious. Since the presumption has shifted and the burden is on the objecting party to show the sum is unreasonable under the circumstances, that party must present affirmative evidence of those circumstances. And keep in mind, if your party has admitted the likely damages, the clause will usually be found valid.
This review was written by the Hon. Meredith Jury (U.S. Bankruptcy Judge, C.D. CA., Ret.), a member of the ad hoc group. Thomson Reuters holds the copyright to these materials and has permitted the Insolvency Law Committee to reprint them. This material may not be further transmitted without the consent of Thomson Reuters.