Honchariw v. FJM

When a late fee is assessed upon the entire principal balance of the loan, is it invalid when the loan is not fully matured? This question, so important to lenders, has been addressed in California after the conclusion of state litigation, and the answer appears to be yes. This is important, as some law firms in Southern California are targeting lenders who have charged and collected late fees based on the unpaid principal balance and are filing lawsuits against those lenders for damages including punitive damages and attorneys’ fees and costs. We anticipate that the practice will proliferate in the coming months, so lenders beware!

In Honchariw v. FJM, now current law, the court found that liquidated damages assessed upon the entire principal balance of the loan, when the loan is not fully matured, is an unlawful penalty. This applies to liquidated damages applied as a result of both monetary and non‑monetary defaults.

However, it appears that this case does not impede the lender’s ability to assess default interest upon the entire principal balance of a loan that is fully matured. Furthermore, this case should not impede upon the lender’s ability to apply a one-time late fee assessed against an overdue payment.

The Details of the Case

In December 2018, the plaintiffs, Nicholas and Sharon Honchariw, took out a $5.6 million-dollar commercial bridge loan with an 8.5% annual interest rate from the defendant, FJM Private Mortgage Fund, LLC. When the Plaintiffs missed a monthly payment, it triggered the late-payment fee provision set forth in the loan agreement, and a default interest charge of 9.99% per annum was assessed against the entire principal balance of the loan. Pursuant to the terms of the loan agreement, this new default interest rate of 9.99% assessed against the entire principal balance of the loan would be applied monthly to the entire unpaid loan balance from the time of default until the loan was paid off, or until the specific default had been cured.

Current California law provides that a liquidated damages provision, i.e. a late-payment fee, is presumptively invalid if it is related to a consumer contract, but a liquidated damages provision is presumptively valid if it’s related to a non-consumer contract.

According to Section 1671 of the California Civil Code, a consumer contract is one that involves the “retail purchase, or rental of personal property or services, primarily for personal, family, or household purposes, or a lease of real property for use as a dwelling.” All other contracts are non-consumer contracts, i.e. business contracts.

Regardless of whether the contract is a consumer or non-consumer contract, the amount of liquidated damages must bear a reasonable relationship to the actual damages that the parties would anticipate be caused by the breach. (Garrett v. Coast & Southern Fed. Sav. & Loan Assn. (1973) 9 Cal.3d 731, 739.) In the absence of such relationship, a liquidated damages clause may be construed as a penalty, which is unlawful and invalid.

Late-payment fees serve a dual purpose – first, to compensate the lender for its administrative expenses and the cost of money wrongfully withheld, and second, to encourage the borrower to make timely future payments. (Garrett, supra, 9 Cal.3d at pp. 739-740.) However, late payments may be invalid if their primary purpose is to compel payment through threat of charges bearing little or no relationship to the amount of actual loss incurred by lender (Garrett, supra, 9 Cal.3d at pp. 740.)

The Supreme Court previously held that a late payment of a loan installment which is measured against the entire principal balance of the loan must be deemed to be punitive in character because it is an attempt to coerce timely payment by a forfeiture which is not reasonably calculated to merely compensate the injured lender. (Ibid.) In essence, the court found that this type of late fee does not bear a reasonable relationship to the amount of actual losses incurred by the lender, and therefore, this type of late fee is invalid.

What This Case Stands For

As stated above, the court found that liquidated damages assessed upon the entire principal balance of the loan, when the loan is not fully matured, is an unlawful penalty and violates California law, applying to liquidated damages applied as a result of both monetary and non‑monetary defaults.

This case was appealed to the California Supreme Court, but the appeal was denied in December 2022. Therefore, this case rests as current law.

As also noted above, it appears that this case does not impede the lender’s ability to assess default interest upon the entire principal balance of a loan that is fully matured. Nor should it impede upon the lender’s ability to apply a one-time late fee assessed against an overdue payment.

It is important to note that at this time, the result of this case still governs as California law. Therefore, if a lender is to charge a late fee assessed on the entire principal balance of the loan that is not fully mature, the borrower could make a claim against the lender, even after loan payoff.

We have already noticed that there are law firms in Southern California who are targeting lenders who have charged and collected late fees based on the unpaid principal balance and are filing lawsuits against those lenders for damages including punitive damages and attorneys’ fees and costs. Again, lenders should be on their toes, because we anticipate that the practice will proliferate in the coming months.