California Supreme Court Rejects Appeal of Default Interest Case

As previously reported (Sidebar Issue 145), the California Court of Appeals determined that a default interest rate and late fee charges are unlawful when assessed against the entire outstanding loan amount following the failure to pay one installment, and thus could not be collected by the lender. Honchariw v. FJM Private Mortgage Fund, LLC, 83 Cal.App.5th 893. On December 21, 2022, the California Supreme Court denied the lender’s request to review and depublish the decision, thus confirming the Court of Appeals ruling in Honchariw.

In the underlying case, Nicholas and Sharon Honchariw defaulted on the payment of one installment of a commercial loan bearing interest at 8.5% per annum. As a result, the lender charged a one-time fee of 10% of the missed installment and began charging default interest at the rate of 9.99% per annum on the entire unpaid balance of the loan (together, the “Late Fee”). The Court of Appeals held that the Late Fee as liquidated damages had to bear a “reasonable relationship” to the actual damages anticipated to be suffered by the parties as a consequence of the borrower’s default and that the lender had failed to demonstrate such a reasonable relationship. Without such a demonstration, the Late Fee is violative of Civil Code section 1671 (Liquidated Damages) and constitutes an unlawful penalty.

While the decision in Honchariw is final, its further implications are unclear. The determination of a “reasonable relationship” is a fact-based determination. Thus, even on an installment payment default, a future lender may be able to substantiate the relationship between the liquidated damages late fee and the actual damages that the lender might reasonably anticipate. Further, the possibility remains that a lender may be able to charge default interest on the entire unpaid balance of a loan following the acceleration of the loan due to a monetary or non-monetary default. At that point, the entire unpaid balance would be due, not just a single installment. This acceleration issue was not before the Court of Appeals in Honchariw.

For the time being, expect lenders to be more judicious in asserting Late Fees for installment payment defaults and borrowers to be more aggressive in contesting Late Fees asserted prior to acceleration of the full loan balance. Lenders and borrowers would be well served by consulting with legal counsel regarding the inclusion of Late Fee provisions in their future contracts as well as the implementation of any such .provisions in their current contracts.