New Jersey Superior Court Restricts Lenders’ Ability to Collect Late Fees and Default Interest

In the recent case of MetLife Capital Financial Corporation v. Washington Avenue Associates (N.J. Super., 1998), the New Jersey Superior Court considered the enforceability of provisions in a note which imposed a 5% late fee on overdue installments and increased the interest rate on the note to 15% (a 5.45% increase over the contract rate) following the occurrence of a default. The court determined that both the late fee and the default rate were unenforceable penalty charges since, based upon evidence presented to the trial court, they were not reasonably related to the anticipated damage likely to be suffered by the lender because of the default.

The court's decision with respect to the late charge was based, in part, upon the five percent figure; however, both the language and the reasoning of the opinion suggest that any late charge measured by a fixed percentage of the installment may be unenforceable, regardless of the actual percentage. According to the court, the purpose of imposing a fixed percentage late fee is to "…provide an incentive to the borrower, on pain of incurring the late charge, to make timely payments….[I]t is well settled that a purpose to coerce timely payments renders the charge so imposed a penalty by definition." The opinion suggests that a "modest flat service fee" for late installments would be enforceable.

The late fee and default interest rate provisions reviewed by the court in this case are by no means atypical in commercial transactions, and the amounts of the default charges under the note were well within the range of standard practice. Washington Avenue Associates places upon the lender the significant burden of establishing that the default charges imposed upon a borrower are a reasonable estimate of the additional costs and damages which the lender is likely to incur because of a default. Lenders should re-evaluate the default provisions of their standard loan documents in light of the court's decision.