Points of Interest Summer 2019 Page 31 efault interest is intended to compensate a lender for the additional cost and delay resulting from a borrower’s default on the loan. DefaultInterestRateprovisionscomeinall sizesandarefoundinmanydifferenttypes ofmortgageloans. Whiletheseprovisions arenotprohibited,courtsoftenviewthem with a suspicious eye. As discussed in this article, Bankruptcy courts in particular, do not like Default Interest Rate provisions. Fortunately, this one has a happy ending. On March 6, 2019, in East West Bank v. Altadena Lincoln Crossing, LLC (C.D. Cal., Mar. 6, 2019, No. 2:17-BK-14276-BB) 2019 WL 1057044, the United States District Court for the Central District of California reversed the Bankruptcy Court, holding thatCalifornia’sliquidateddamagesstatute does not apply to, or invalidate, a lender’s Default Interest Rate (“DIR”) provision. The Court then upheld the DIR provision, finding that there was a reasonable relationship between the default interest charged and the anticipated damages to the lender caused by the default. While this is a very positive result for California lenders, the decision is on further appeal. So stay tuned! By way of background, in 2005, Altadena LincolnCrossing,LLC(“Altadena”)obtained If You Charge Default Interest, You'll Want to Read This! by T. Robert Finlay, Esq. Wright, Finlay & Zak, LLP by Taylor E. Hubbard, Esq. Wright, Finlay & Zak, LLP a loan from East West Bank (“EWB”) to finance a construction project, repayment of which was secured by a deed of trust on the property. The heavily negotiated loan agreement contained an industry standard generic provision increasing the annual interest rate by 5% in the event of Altadena’s default. While the loan agreement was heavily negotiated, the DIR provision was not discussed. Ultimately, Altadena failed to repay the loan upon maturity in 2009, triggering the DIR provision. After eight years and thirteen forbearance agreements, EWB commenced foreclosure proceedings, resulting in Altadena filing for Bankruptcy. In its objections to EWB’s proof of claim for its loan, Altadena argued that the DIR provisionconstitutedanunreasonableand unenforceable penalty under California’s liquidated damages statute found in California Civil Code § 1671(b). Civil Code § 1671(b) provides that “a provision in a contract liquidating the damages for the breach of the contract is valid unless the party seeking to invalidate the provision establishes that the provision wasunreasonableunderthecircumstances existingatthetimethecontractwasmade.” The Bankruptcy Court ruled that the DIR provision was unreasonable and, as a result, was an unenforceable penalty under § 1671(b). The Bankruptcy Court noted that a liquidated damages clause is considered unreasonable if the clause bears no reasonable relationship to the actual damages which the parties could have anticipated would result from a breach at the time the contract was made. Additionally, the amount of liquidated damages must represent the result of a reasonable endeavor by the parties to estimate a fair average compensation for any loss that may be sustained. Here, because EWB used an industry standard andgenericDIRprovisionanddidnoteven discuss the provision during negotiations, the Bankruptcy Court concluded that the DIR provision was not included in the loan agreement pursuant to “reasonable endeavor” by the parties to estimate the actual damages EWB would suffer as a result of Altadena’s default. EWBwiselychosetobypasstheBankruptcy Appellate Panel (“BAP”) and, instead, appealed the decision to the Federal Court’s Central District. On appeal, the Central District Court overturned the prior decision, holding that not only is § 1671(b) inapplicable, even if it was, its application would not invalidate EWB’s DIR provision. continued on page 32