Honchariw v. FJM Private Mortgage Fund, LLC ( 2022 )

Filed 9/29/22
CERTIFIED FOR PUBLICATION
IN THE COURT OF APPEAL OF THE STATE OF CALIFORNIA
FIRST APPELLATE DISTRICT
DIVISION THREE
NICHOLAS AND SHARON
HONCHARIW,
Petitioners and Appellants,
v. A163756
FJM PRIVATE MORTGAGE FUND,
LLC, et al., (Sonoma County
Super. Ct. No. SCV267331)
Defendants and Respondents.
In the case before us, petitioners and appellants Nicholas and Sharon
Honchariw took out a loan secured by real property. When they defaulted,
the lender imposed a late-payment fee provided for in their loan agreement.
The Honchariws commenced arbitration, in which they contended the late-
payment fee was unlawful (1) pursuant to regulations applicable to a
mortgage-loan originator with a license regulated by the Department of Real
Estate, and (2) because it was a liquidated damage constituting an unlawful
penalty in violation of section 1671. 1 The arbitrator denied both claims. A
petition to vacate the arbitration award in the trial court failed, and the order
on that petition was appealed.
1Unless otherwise specified, all further statutory references are to the
Civil Code.
1
We shall reverse as the trial court erroneously failed to vacate an
award that constitutes an unlawful penalty in contravention of the public
policy set forth in section 1671.
FACTUAL AND PROCEDURAL BACKGROUND
Nicholas and Sharon Honchariw took out a $5.6 million dollar bridge
loan, with 8.5% interest assessed per annum, secured by a first lien deed of
trust on real property. Included in the record on appeal is a “NOTE
SECURED BY A DEED OF TRUST,” dated “12/13/2018” and executed
between “FJM Private Mortgage Fund, LLC a California Limited Liability
Company, as to an undivided 100.00% interest (CFL License # 6054701) (who
will be called ‘Lender’)” and Nicholas and Sharon Honchariw (the “Loan”).
(FJM Private Mortgage Fund, LLC is hereinafter referred to as “FJM Fund.”)
The Honchariws defaulted on their September 1, 2019, monthly
payment. By missing that payment of $39,667, the Honchariws triggered
certain late-payment fee provisions set forth in the Loan: (1) a one-time 10%
fee assessed against the overdue payment ($3,967); and (2) a default interest
charge of 9.99% per annum assessed against the total unpaid principal
balance of the Loan (“any unpaid principal balance of the loan at the time of
default shall bear interest at the rate of nine and ninety-nine percent (9.99%)
. . . above the herein stated note rate, automatically and without notice, from
the time of default, until this Note has been paid in full, or until the specific
default has been cured”). We shall refer to the sum of these amounts as the
“Late Fee.”
The Honchariws filed a demand for arbitration on October 7, 2019. The
arbitration demand alleged (1) the Loan was in violation of the “Real Estate
Loan [L]aw,” (Business & Professions Code § 10240, et seq.), and (2) the Late
Fee was an unlawful penalty in violation of section 1671. “First Bridge
2
Lending” and “FJM Capital, Inc.” (hereinafter jointly referred to as “FJM
Capital”) averred the loan was not subject to the Real Estate Loan Law, and
that the late-payment fee did not violate section 1671. The arbitrator agreed
with FJM Capital on both points and denied the demand for arbitration. We
shall refer to the arbitration award as “the Award.”
The Honchariws petitioned to vacate the Award in November 2020.
They sought to vacate the Award on the basis that the arbitrator exceeded
their authority by denying claims in violation of “nonwaivable statutory
rights and/or contravention of explicit legislative expressions of public policy,”
specifically identifying both the rights protected by the Real Estate Loan
Law’s prohibition against lenders charging more than 10% of the installment
amount due (Bus. & Prof. C., §§ 10248.1, 10242.5) and section 1671.
The trial court denied the petition, holding the Honchariws “ ‘did not
meet their burden of proof’ to show that the ‘default interest provision in the
subject loan was invalid as a penalty. . . .’ ” “[E]ven when the Court considers
the evidence presented in this motion, the Court cannot conclude that the
arbitrator exceeded her powers by denying [the Honchariws’] claims.”
A timely appeal ensued.
DISCUSSION
I. Standard of Review and Governing Law
An arbitrator’s decision “is not generally reviewable for errors of fact or
law, whether or not such error appears on the face of the award and causes
substantial injustice to the parties.” (Moncharsh v. Heily & Blase (1992) 3
Cal.4th 1, 6 (Moncharsh).) 2 Code of Civil Procedure section 1286.2 provides
2
The parties dispute whether the trial court conducted a de novo
review of the arbitral decision in addition to its deferential review and the
trial court order itself is not clear on the standards employed. As explained,
infra, we review the arbitrator’s decision on a de novo basis. Therefore, the
3
an exception to this general rule where “[t]he arbitrators exceeded their
powers and the award cannot be corrected without affecting the merits of the
decision upon the controversy submitted.” (Code Civ. Proc., § 1286.2, subd.
(a)(4); see also, City of Palo Alto v. Service Employees Internat. Union (1999)
77 Cal.App.4th 327, 333.)
“Arbitrators may exceed their powers by issuing an award that violates
a party’s unwaivable statutory rights or that contravenes an explicit
legislative expression of public policy. [Citations.]” (Richey v. AutoNation,
Inc. (2015) 60 Cal.4th 909, 916 (Richey).) The public policy so contravened
must be a “well-defined and dominant” public policy as “ascertained ‘by
reference to the laws and legal precedents and not from general
considerations of supposed public interests.’ ” (W.R. Grace and Co. v. Local
Union 759, Intern. Union of United Rubber, Cork, Linoleum and Plastic
Workers of America (1983) 461 U.S. 757, 766 (W.R. Grace); see also
Department of Human Resources v. International Union of Operating
Engineers (2020) 58 Cal.App.5th 861, 873–880.) “ ‘[W]hether the arbitrator
exceeded his or her powers . . ., and thus whether the award should have
been vacated on that basis, is reviewed on appeal de novo.’ [Citation.]” (See
Ahdout v. Hekmatjah (2013) 213 Cal.App.4th 21, 33.)
A brief review of section 1671 is sufficient to conclude that it expresses
“well-defined and dominant” public policy such that a challenge predicated
thereon escapes the general prohibition against review of arbitral decisions.
(See W.R. Grace, supra, 461 U.S. at p. 766; Moncharsh, supra, 3 Cal.4th at
pp. 31–33; Richey, supra, 60 Cal.4th at p. 916.)
standards applied by the trial court, including any potential error resulting
from the standard applied, is of no consequence.
4
Section 1671 provides that a liquidated damages provision is either
presumptively valid or invalid depending upon the subject matter of the
contract. If the contract involves “the retail purchase, or rental . . . of
personal property or services, primarily for . . . personal, family, or household
purposes,” (§ 1671, subd. (c)(1)), or involves “a lease of real property for use as
a dwelling,” (§ 1671, subd. (c)(2)), then a liquidated damages provision in that
contract is presumptively void. (§ 1671, subd. (d).) We shall refer to those
contracts described by subdivisions (c)(1)–(c)(2) as “consumer contracts.” For
all other contracts, which we shall refer to as “non-consumer contracts,” “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 was unreasonable under the circumstances existing at the time
the contract was made.” (§ 1671, subd. (b).)
Simply put, a liquidated damages provision is presumed valid if it is in
a non-consumer contract but presumed invalid if it is in a consumer contract.
(See Ridgley v. Topa Thrift & Loan Assn. (1998) 17 Cal.4th 970, 977
(Ridgley).) The case before us involves a non-consumer contract as it is
neither for the purchase of property for personal use nor does it involve a
primary dwelling. (§ 1671, subds. (c)(1)–(c)(2).) Whether or not an agreement
is a non-consumer contract or consumer contract, it may not violate public
policy.
Section 1671 expresses clear public policy as “ascertained ‘by reference
to the laws and legal precedents and not from general considerations of
supposed public interests.’ ” (W.R. Grace, supra, 461 U.S. at p. 766.) It is the
public policy of California that liquidated damages bear a “reasonable
relationship” to the actual damages that the parties anticipate would flow
from breach; conversely, if the liquidated damages clause fails to so conform,
5
it will be construed as an unenforceable “penalty.” (Garrett v. Coast &
Southern Fed. Sav. & Loan Assn. (1973) 9 Cal.3d 731, 739 (Garrett).) The
amount set as 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.” (Ibid.) In the absence of such relationship, a
contractual clause purporting to predetermine damages “must be construed
as a penalty.” (Ibid.) “Civil Code section 1671 and the case law interpreting
it aim to combat unfair and unreasonable coercion arising from an imbalance
of bargaining power.” (Constellation-F, LLC v. World Trading 23, Inc. (2020)
45 Cal.App.5th 22, 27.)
Because an arbitrator may exceed their powers by enforcing a contract
that is in violation of public policy, we conclude de novo review is appropriate.
(Moncharsh, supra, 3 Cal.4th at p. 31.) “Based on section 1671(b)’s
presumption that liquidated damage provisions in nonconsumer contracts are
valid, the party challenging the provision bears the burden to show the
provision was unreasonable under the circumstances existing when the
parties entered into the contract. [Citations.]” (Vivatech Internat., Inc. v.
Sporn (2017) 16 Cal.App.5th 796, 806.)
II. The Late Fee Violates Civil Code Section 1671 3
The Late Fee provided for the following penalty based on even one
missed monthly payment at any time during the life of the Loan: a one-time
10% fee of the overdue monthly payment and a default interest charge of
9.99% per annum assessed against the total amount of unpaid principal
balance of the Loan.
3We do not reach the issue of which regulatory scheme governed the
Loan as it is not necessary to do so in order to resolve this appeal.
6
As our Supreme Court explained in Garrett, late-payment fees serve a
“dual purpose.” First, they are “compensat[ion] [to] the lender for its
administrative expenses and the cost of money wrongfully withheld.”
(Garrett, supra, 9 Cal.3d at pp. 739–740.) Second, “they encourage the
borrower to make timely future payments.” (Ibid.) Late-payment fees,
however, may violate section 1671 and amount to unlawful penalties if their
“primary purpose is to compel prompt payment through the threat of
imposition of charges bearing little or no relationship to the amount of the
actual loss incurred by the lender.” (Id. at p. 740.)
The late-payment fee reviewed in Garrett was assessed against the
“unpaid principal balance of the loan obligation.” (Garrett, supra, 9 Cal.3d at
p. 740, italics in original.) Our Supreme Court held that such “a charge for
the late payment of a loan installment which is measured against the unpaid
balance of the loan must be deemed to be punitive in character.” (Ibid.) The
Court reasoned this is because “[i]t is an attempt to coerce timely payment by
a forfeiture which is not reasonably calculated to merely compensate the
injured lender.” (Ibid.) Further, “a borrower on an installment note cannot
legally agree to forfeit what is clearly a penalty in exchange for the right to
exercise an option to default in making a timely payment of an installment.”
(Id. at p. 737.)
FJM Capital argues that Garrett cannot be relied upon to decide the
legality of the Late Fee here imposed because it reviewed a prior version of
section 1671 (revised effective July 1, 1978) that made all liquidated damages
provisions (regardless of the characterization of the contract at issue)
presumptively invalid. It goes so far as to say that Garrett was “legislatively
overruled” with the enactment of current section 1671. We disagree. While
the current version of section 1671 declares all liquidated damages clauses
7
presumptively invalid as to consumer contracts (as opposed to all contracts), 4
Garrett remains good law for the proposition that a late fee assessed against
the entire unpaid balance of a loan constitutes an unlawful penalty and there
is nothing in current section 1671 or the case law following Garrett holding
otherwise.
In Ridgley, supra, 17 Cal.4th at pp. 977–982, decided two decades after
the enactment of current section 1671, our Supreme Court considered the
legality of a liquidated damages provision in a non-consumer contract,
specifically referring to section 1671, subdivision (b). (See Ridgley, supra, 17
Cal.4th at p. 977 [“ ‘[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 was unreasonable under the
circumstances existing at the time the contract was made.’ ”].) It reversed
the lower court, finding a promissory note to contain an unlawful penalty
where it imposed six months’ interest if the borrowers prepaid the loan
principal, but also provided that the six months’ interest charge would not be
imposed six months after execution of the note unless the borrowers had
made a late interest payment or otherwise defaulted. (Id. at p. 980.)
In so doing, it cited to Garrett approvingly and without reservation: “ ‘a
charge for the late payment of a loan installment which is measured against
the unpaid balance of the loan must be deemed to be punitive in character. It
4 Former section 1670 provided: “ ‘Every contract by which the amount
of damage to be paid, or other compensation to be made, for a breach of an
obligation, is determined in anticipation thereof, is to that extent void, except
as expressly provided in the next section.’ ” Former section 1671 read: “ ‘The
parties to a contract may agree therein upon an amount which shall be
presumed to be the amount of damage sustained by a breach thereof, when,
from the nature of the case, it would be impracticable or extremely difficult to
fix the actual damage.’ ” (See Garrett, supra, 9 Cal.3d at p. 734, fn. 1.)
8
is an attempt to coerce timely payment by a forfeiture which is not
reasonably calculated to merely compensate the injured lender.’ ([Garrett,
supra, 9 Cal.3d] at p. 740, fn. omitted; [Citations.]”) (Ridgley, supra, 17
Cal.4th at p. 978.) 5 As the Ridgley court explained: “In short, ‘[a]n amount
disproportionate to the anticipated damages is termed a “penalty.” ’ ” (Id. at
p. 972.) “A contractual provision imposing a ‘penalty’ is ineffective, and the
wronged party can collect only the actual damages sustained.” (Perdue v.
Crocker National Bank (1985) 38 Cal.3d 913, 931; see also Ebbert v.
Mercantile Trust Co. of California (1931) 213 Cal. 496, 499 [“[A]ny provision
by which money or property would be forfeited without regard to the actual
damage suffered would be an unenforceable penalty.”].)
More recently, in another non-consumer contract case, the Federal
District Court for the Northern District of California, in Najarian Holdings
LLC v. Corevest American Finance Lender LLC, found late-payment fees
calculated as a percentage of the outstanding principal balance to be void
under section 1671. (Najarian Holdings LLC v. Corevest American Finance
Lender LLC, 2020 U.S. Dist. LEXIS 188667, 2020 WL 5993225 at pp. *1–2
(N.D. Cal. Oct. 9, 2020) [plaintiffs are in the business of purchasing
residences at foreclosure sales and then reselling those residences].) In so
doing, it applied Ridgley, supra, 17 Cal.4th at p. 977, which quotes to the
passage reproduced above from Garrett. (See Najarian Holdings LLC v.
Corevest American Finance Lender LLC, at p. *2.) Subsequent California
5 Moreover, even though the loan at issue in Garrett was extended to
finance a primary residence, and thus, would today be considered a
“consumer” loan, (Garrett, supra, 9 Cal.3d at p. 739), Ridgley cited Garrett to
reiterate the same principle, i.e., that late-payment fees assessed upon the
entire unpaid balance of a loan is an unenforceable penalty as a matter of
law. (Ridgley, supra, 17 Cal.4th at p. 978.)
9
appellate court decisions have also cited Garrett, supra, 9 Cal.3d at pp. 739–
740 approvingly, albeit in dicta. (See Creditors Adjustment Bureau, Inc. v.
Imani (2022) 82 Cal.App.5th 131, 136; Greentree Financial Group, Inc. v.
Execute Sports, Inc. (2008) 163 Cal.App.4th 495, 501.) 6
The two cases primarily relied upon by FJM Capital – Walker v.
Countrywide Home Loans, Inc. (2002) 98 Cal.App.4th 1158, 1171 (Walker)
and Hoffman v. Security Pacific National Bank (1981) 121 Cal.App.3d 964,
967, fn. 1 (Hoffman) – are readily distinguishable and do not assist our
analysis. Walker was concerned with whether property inspection fees
should be considered late-payment fees for purposes of section 2954.4, which
limits late-payment fees for certain single-family dwellings. (Walker, supra,
98 Cal.App.4th at pp. 1165–1166.) In reviewing the evolution of the law of
liquidated damages as applied to single-family dwellings, the Walker court
observed that Garrett analyzed a since-superseded liquidated damages
statute and cited to Garrett to illustrate the functions of liquidated damages
clauses. (Walker, supra, 98 Cal.App.4th at p. 1171.) In dicta, the Walker
court stated that if the liquidated damages issue were before it, it would
affirm, as the late-payment fee imposed by the lender bore a reasonable
relationship to the damages the parties expected the lender to sustain upon
breach, thereby satisfying section 1671. (Id. at p. 1172.) Hoffman was
concerned with whether a bank’s charges for its customers writing
insufficient funds checks amounted to penalty damages. (Hoffman, supra,
121 Cal.App.3d at pp. 968–969.) Neither Walker nor Hoffman addressed
whether Garrett remains good law for the proposition that liquidated
6 Garrett, supra, 9 Cal.3d at page 739, is also cited by a leading real
estate treatise for the general proposition that late-payment fees cannot be
assessed against the unpaid principal of a secured loan. (See Miller & Starr,
Calif. Real Estate (4th ed., 2022), § 13:96.)
10
damages assessed against the unpaid principal balance of a loan are
unreasonably related to the lender’s expected damages as a matter of law.
Finally, FJM Capital argues that, whether or not Garrett controls, the
Late Fee represents the parties’ attempt to calculate FJM Capital’s
anticipated damages in the event of default and whatever the parties agreed
to is lawful. This argument is premised upon the parties’ statement in the
Loan documentation that FJM Fund would incur difficult to estimate
expenses 7 as a result of default coupled with the conclusory and de minimis
testimony of Louis Bardis, the “principal owner and managing director” of
FJM Capital. Bardis was asked whether “ ‘the late charge was in fact
representing a fair and reasonable estimate.’ ” He answered: “ ‘Yes.’ ” There
were no follow-up questions and no documentary support. Bardis’ one-word
answer and the parties’ blanket statements in the Loan documentation are
insufficient to support a finding that FJM Capital had attempted to estimate
their damages in the amount of breach and that the Late Fee represents the
reasoned outcome of such an attempt. The answer “ ‘[y]es’ ” is not a
demonstration of a “reasonable relationship” between the Late Fee and “the
range of actual damages that the parties could have anticipated would flow
from a breach.” (Ridgley, supra, 17 Cal.4th at p. 977.)
FJM Capital also cites two bankruptcy cases – East West Bank v.
Altadena Lincoln Crossing, LLC (C.D. Cal. 2019) 598 B.R. 633 (East West)
and In re 3MB, LLC (E.D. Cal. 2019) 609 B.R. 841 (3MB) – for the proposition
7 The Loan indicates that the Late Fee will be assessed because a
default, “will result in [FJM Fund] incurring additional expense in servicing
the loan, including, but not limited to sending out notices of delinquency,
computing interest, and segregating the delinquent sums from not delinquent
sums on all accounting, loan and data processing records, in loss to [FJM
Fund] of the use of the money due, and in frustration to [FJM Fund] in
meeting its other financial commitments.”
11
that “[t]he amount of damages [a lender] actually incurred is irrelevant to the
reasonableness of the liquidated damages clause.” (3MB, supra, 609 B.R. at
p. 851.) FJM Capital argues that actual damages are not relevant where the
parties agree in the loan documents that a liquidated damages amount is
reasonable.
This argument fails. In both East West and 3MB, the borrower
defaulted on fully matured obligations and was assessed a default interest at
maturity. (See East West, supra, 598 B.R. at p. 636; 3MB, supra, 609 B.R. at
p. 848.) Here, just as in Garrett, the borrower defaulted on a partially
mature obligation and was given a choice between making their note
payment or defaulting and facing a “coercive” penalty. (Garrett, supra, 9
Cal.3d at p. 740.) 3MB itself noted that our Supreme Court in Garrett
recognized the significance of the charge being assessed against the entire
principal for a partially matured obligation:
“The [Garrett] court held that late charges based on the entire
unpaid [principal] balance for failure to pay an installment was
punitive and was not rationally calculated to merely compensate the
injured lender. [Citation.] Garrett specifically distinguished Thompson
[v. Gorner (1894) 104 Cal. 168 (Thompson)],[8] noting that at maturity,
the borrower in Thompson ‘owed only what he had contracted to pay
had there been no default, the principal amount plus accrued interest.
If these amounts were not then paid, the parties agreed that interest at
the higher rate would accrue.’ [Garrett, supra, 9 Cal.3d at p. 737.]
That is precisely the situation here. 3MB failed to pay the ‘balloon’ at
maturity and default interest began to accrue.”
(3MB, supra, 609 B.R. at pp. 848–849.)
Further, FJM Capital’s position that the language of the Loan must
govern the result is belied by the language in section 1671 that contains
8
As the 3MB court summarized Thompson: “[D]efault interest
following note maturity has long been allowed in California without resort to
a liquidated damages analysis.” (3MB, supra, 609 B.R. at p. 848.)
12
presumptions, and not conclusions, regarding the validity of a liquidated
damages provision. If, as FJM contends, the validity of a given clause were
purely a function of agreement and the Legislature intended to “legislatively
overrule” former section 1671, it could have provided that liquidated damages
provisions in non-consumer contracts are lawful, full stop. Instead, the
Legislature provided for a presumption of validity (in non-consumer
contracts), which in no way precludes a finding of invalidity where a
liquidated damages presumption violates public policy. (See Becerra v.
Superior Court (2020) 44 Cal.App.5th 897, 917.) The Honchariws cannot be
legally bound by an agreement to pay a late-payment fee that violates public
policy. (See Wilson v. Stearns (1954) 123 Cal.App.2d 472, 480.)
In sum, based on Garrett and its progeny, liquidated damages in the
form of a penalty assessed during the lifetime of a partially matured note
against the entire outstanding loan amount are unlawful penalties. Not
surprisingly, our review of the caselaw reveals no case in which a liquidated
damages provision was upheld when a borrower missed a single installment,
and then was penalized pursuant to that provision, even in part, by a late-
payment fee assessed upon the entire outstanding principal balance, much of
it still to be owed. Put another way, by its very existence, the Honchariws
have met their burden of showing an unlawful penalty. 9 (Garrett, supra, 9
Cal.3d at p. 740.)
9 The Restatement (Second) of Contracts summarizes this principle as
follows: “The central objective behind the system of contract remedies is
compensatory, not punitive. Punishment of a promisor for having broken his
promise has no justification on either economic or other grounds and a term
providing such a penalty is unenforceable on grounds of public policy.” (§ 356
Liquidated Damages and Penalties.)
13
Thus, because the Late Fee includes a 9.99% interest rate assessed
against the entire unpaid principal balance of the Loan at any time a single
payment is missed, it is indistinguishable from the late-payment fee
invalidated in Garrett. We shall reverse.
DISPOSITION
The order is reversed. The Honchariws shall recover their costs on
appeal.
14
_________________________
Petrou, J.
WE CONCUR:
_________________________
Fujisaki, Acting P.J.
_________________________
Rodríguez, J.
A163756/Honchariw v. FJM Private Mortgage Fund, LLC, et al.
15
Trial Court: Sonoma County Superior Court
Trial Judge: Hon. Jennifer V. Dollard
Counsel: Nicholas Honchariw, in pro. per., for Petitioners and
Appellants.
Law Offices of Mark J. Romeo and Mark J. Romeo for
Defendants and Respondents.
16