Supreme Court Approves Late Charge, Default Interest Rate

The American legal system allows for some very dramatic turns of events. Decisions may be overturned, sometimes many times over the course of years with different issues or outcomes arising at different levels of review. The following is an example of just such a process, in which both the Appellate and Supreme courts had differing opinions regarding the trial court's decision.

In a unanimous decision that will come as a great relief to lenders and other creditors, the New Jersey Supreme Court recently reversed a decision of the New Jersey Superior Court, Appellate Division, in which the Appellate Division had refused to enforce commercial loan provisions that provided for a 5% late fee and increased default rate of interest on a delinquent financial obligation. The Supreme Court disagreed with the Appellate Division's conclusion, in MetLife Capital Financial Corporation v. Washington Avenue Associates, that the late fees and default rate of interest amounted to unenforceable penalties, and held that a five-percent late fee and default rate of interest of three-percent about the contract rate were each reasonable liquidated damages collectable on a delinquent promissory note.

The Supreme Court pointed out that liquidated damages clauses in commercial contracts between sophisticated parties are presumed to be reasonable, which means that the party challenging the validity of such a clause has the burden of establishing that the terms are unreasonable. The Appellate Division had ruled that the late fee was unreasonable, in part because the Appellate Division did not believe that the damages suffered by the lender would vary the amount due. The Supreme Court flatly disagreed with this position, concluding that a late payment on a large loan would present a greater risk to the lender, and that the investment opportunity lost to the lender increases with the size of the late payment. In addition, the Supreme Court pointed out that a five-percent late fee is approved by statute in a number of other contexts, both in New Jersey and elsewhere.

Using similar reasoning, the Supreme Court upheld a default rate of interest that had been modified by the trial court to be three percent over the contract rate. The loan documents had provided for a default rate of the greater of five-percent over the prime rate, or fifteen-percent. The lender did not appeal the trial court's decision to modify the default rate, and the Supreme Court expressed no opinion as to whether it would have upheld the default rates provided for in the loan documents.

Unfortunately (for lenders), the Court limited its holding to commercial loan transactions, and refused to express an opinion regarding the enforceability of liquidated damages provisions in consumer contracts or in residential mortgages. As a result, there will continue to be some uncertainty regarding the enforceability of such provisions in consumer transactions.

The litigants in this action can, now that a final verdict has been rendered, breathe easy now that there are no more surprises in store for them. At least not until the issue arises again.

*article courtesy of Thomas A. Clark.