3MB, LLC

UNITED STATES BANKRUPTCY COURT 1 EASTERN DISTRICT OF CALIFORNIA 2 FRESNO DIVISION 3 4 In re ) Case No. 18-14663-B-11 ) 5 3MB, LLC, ) DC No. LKW-10 ) 6 ) Debtor. ) 7 ) ) 8 ) 9 10 11 MEMORANDUM DECISION ON DEBTOR 3MB’S OBJECTION TO 12 ALLOWANCE OF U.S. BANK’S AMENDED CLAIM 13 14 INTRODUCTION 15 Debtor limited liability company borrowed about $9.5 16 million from claimant’s predecessor secured by the debtor’s 17 shopping center and the rents the center generates. The debtor 18 could not retire the loan when it matured two- and one-half 19 years ago. Then this chapter 11 case was filed halting 20 claimant’s foreclosure efforts. Claimant filed a proof of 21 claim. The debtor now objects to the default interest portion 22 of the claim. Debtor contends the default interest is 23 unenforceable as an invalid liquidated damage clause under 24 California and Bankruptcy law. Finding the default interest 25 provision is not a liquidated damages clause or if the debtor is 26 correct and it is a liquidated damages clause, it is valid, the 27 court overrules the objection. 28 /// 1 PERTINENT FACTS 2 Pre-Petition Events 3 3MB, LLC is a California Limited Liability Company that 4 owns and operates a shopping center on 24th St. in Bakersfield, 5 California. There are two members: Robert Bell (“Bell”) and 6 Mark E. Thomas (“Thomas”). Bell and Thomas have been involved 7 in various commercial transactions for at least twenty-five 8 years. 9 When its business began thirteen years ago, 3MB borrowed 10 $6.4 million from Prudential Mortgage Capital Company, LLC 11 (“Prudential”), signed a note and granted Prudential a deed of 12 trust and assignment of rents encumbering the shopping center. 13 Six months later, the financing was restructured into two notes 14 secured by the same collateral: an “Earnout Promissory Note” in 15 the principal amount of $3.05 million and a “Consolidated 16 Promissory Note” (“Note”) covering the original and earnout 17 notes for a principal amount of $9.45 million. 3MB apparently 18 had counsel prepare an opinion letter to satisfy Prudential as a 19 condition to the restructure.1 20 The “Note (interest) Rate” is 6.27% per annum.2 The Note 21 contains a provision for default interest — 4% plus the Note 22 Rate — and is applied at maturity under clause 2.2 of the Note 23 which says, in part: 24 . . . at all times after maturity of the indebtedness 25 evidenced hereby . . . interest shall accrue on the outstanding principal balance of this Note from the 26 date of the default at the Default Rate, and such 27 1 Initially 3MB claimed it did not have counsel when the restructure was 28 negotia 2 t Te hd e. N oC tl ea i pm ra on vt i dh ea ss tp hr ae ts e tn ht ee d a pe pv li id ce an bc le e e ls at wa b tl oi s bh ei n ag p po lt ih ee dr w ii ss e t. h e law where the collateral is located; that is California. default interest shall be immediately due and payable. 1 Borrower acknowledges that it would be extremely 2 difficult or impracticable to determine Lender’s actual damages resulting from any late payment, Event 3 of Default or prepayment, and the late charges, default interest and prepayment fees, premiums, fees 4 and charges described in this Note are reasonable 5 estimates of those damages and do not constitute a penalty.3 6 7 Bell testified in his declaration that when the loan was 8 negotiated there was no discussion why the default interest 9 provision was included in the Note or the damages Prudential may 10 suffer if the Note was not paid at maturity. The testimony has 11 not been disputed. 12 Bell also testified that Prudential never identified any 13 damages it would incur upon default that would be charged to the 14 debtor. Bell claimed his understanding of default interest 15 provisions was an incentive against default and to “penalize” 16 the debtor if there was a default. 17 After a series of interim transfers and a merger, the Note 18 was assigned to claimant U.S. Bank, N.A. as successor Trustee 19 for the registered holders of Bear Stearns Commercial Mortgage 20 Securities Inc. Commercial Mortgage Pass-Through Certificates, 21 Series 2007-PWR16 (“U.S. Bank”). U.S. Bank is the undisputed 22 holder and owner of the Note and the rights to enforce the 23 obligations against the collateral. 24 During the Note’s term, 3MB made all required payments. 25 The Note matured in May 2017. 3MB tried to refinance without 26 success. U.S. Bank began enforcing its security interest and 27 started a nonjudicial foreclosure. U.S. Bank also filed an 28 3 T h e d e f a u l t r a t e a p p l i e s in other circumstances of default, not just a maturity default. 1 action in the Kern County Superior Court and sought appointment 2 of a receiver. A trustee’s sale was scheduled for November 21, 3 2018. Two days before the sale, this Chapter 11 case was filed. 4 5 Pertinent Post-Petition Events 6 3MB has consistently claimed in its schedules, amended 7 schedules and elsewhere the value of the shopping center is $12 8 million. U.S. Bank filed a proof of claim in December 2018 9 which was amended nine months later. In the amended claim, U.S. 10 Bank says the value of the shopping center is $9.3 million. 11 U.S. Bank’s initial claim was for $8.578 million which 12 included $498,538.61 of default interest.4 The amended claim is 13 for $8.951 million. The difference includes over $200,000 of 14 accruing default interest, $327,710 of “note rate” interest and 15 subtraction of a “suspension credit.”5 For purposes of this 16 objection, at least, U.S. Bank appears over secured. 17 U.S. Bank and 3MB agreed to use of cash collateral. The 18 order approving the stipulation was entered. 3MB has made the 19 payments under the order. 20 After the expiration of debtor’s exclusive time to file a 21 plan under 11 U.S.C. § 1121(b), U.S. Bank filed a creditor’s 22 plan and disclosure statement. Under this proposed plan, U.S. 23 Bank would employ a manager to take over the day-to-day 24 operations of the shopping center. U.S. Bank would sell the 25 center. After the center was sold, U.S. Bank would be paid. 26 4 As will be seen shortly, this is the only component of the claim 3MB 27 finds objectionable. 28 payment5 sT h ue n dc eo ru r at cs au sr hm i cs oe ls l at th ei rs a l“ c sr te id pi ut l” a tr ie op nr e as ne dn t os r da ed re .q u a Bt ue t ,p r to ht ee c st oi uo rn c e of the credit is irrelevant to this objection. 1 Except for payment of any claims of insiders, U.S. Bank proposes 2 to pay non-insider unsecured creditors in full.6 The plan also 3 proposed to “hold back” any disputed amounts of default interest 4 until the litigation concerning that issue was resolved. 5 Shortly after U.S. Bank’s plan was filed, 3MB proposed its 6 own plan and disclosure statement. The current management 7 structure would remain in place under the plan and U.S. Bank’s 8 loan would be restructured to be paid out over time with 9 interest. Default interest would not be paid. 3MB claims the 10 allowance of the default interest would make its plan 11 infeasible. 3MB also claims that the insider unsecured 12 creditors and all other unsecured creditors would be paid in 13 full under its plan. 14 Almost concurrently, 3MB filed this objection to the 15 default interest component of U.S. Bank’s claim. With the 16 court’s encouragement, the parties prepared a joint disclosure 17 statement discussing both of their plans. The disclosure 18 statement has been approved. No plan solicitations have 19 occurred. The parties await the ruling on the allowance of 20 default interest. 21 22 CONTENTIONS OF THE PARTIES 23 3MB argues that the default interest provision is an 24 unenforceable liquidated damage clause under California law. 25 The amount of default interest — 4% over the Note rate — was 26 unreasonable at the time the Note was made, claims the debtor. 27 28 collect6 oO rt ,h e tr h et rh ea n i st h oe n es e oc tu hr ee rd nc ol na -i im n so if d et rh e c rK ee dr in t oC ro u tn ht ay t T fr ie la es du r ae r c la an id m T ia nx the case for a modest amount. Bell’s claim is for $292,000; Thomas’— $342,000. 1 Since the liquidated damage is a penalty, under debtor’s theory, 2 it is unenforceable under California law and under bankruptcy 3 law. Debtor also argues that the default interest rate should 4 be disallowed on equitable grounds. Default interest, says 3MB, 5 is inequitable because: 3MB performed under the Note before 6 maturity; 3MB’s proposed plan provides for payment of all 7 principal, interest, costs and expenses owed U.S. Bank; U.S. 8 Bank will receive “a windfall” if default interest is allowed; 9 and, the debtor’s reorganization will be prejudiced if default 10 interest is allowed. 11 U.S. Bank counters that default interest is not liquidated 12 damages under California and bankruptcy law. Instead, incurring 13 default interest is “alternative performance” under a matured 14 note and authorized under long standing California precedent. 15 The default interest involved here compensates the lender for 16 the impact on the loan’s value since it is now due and the 17 resulting increased “carrying” costs. U.S. Bank offered expert 18 testimony from Cynthia Nelson which has not been challenged that 19 default interest is common in commercial loan transactions of 20 this size. Also, the default interest balance due is only 4% of 21 the loan balance and so, very reasonable. Even if the default 22 interest is analyzed as liquidated damages, U.S. Bank reasons, 23 the debtor has not met its burden under California law to 24 invalidate the default interest provision of the Note. 25 26 JURISDICTION 27 The United States District Court for the Eastern District 28 of California has jurisdiction of this civil proceeding since it 1 arises in a case under title 11 of the United States Code under 2 28 U.S.C. § 1334(b). The district court has referred this 3 matter to this court under 28 U.S.C. § 157(a). This is a “core” 4 proceeding under 28 U.S.C. § 157(b)(2) (A) and (B).7 5 6 ANALYSIS 7 This court’s legal conclusions are reviewed de novo and 8 factual findings for clear error. Neilson v. Chang (In re First 9 T.D. & Inv., Inc.), 253 F.3d 520, 526 (9th Cir. 2001). 10 Allocation of burden of proof and those issues involving 11 statutory interpretation are legal questions invoking de novo 12 review. Curtis v. Shpak (In re Curtis), 571 B.R. 441, 444 13 (B.A.P. 9th Cir. 2017). Liquidated damages awards are reviewed 14 for abuse of discretion. Traxler v. Multnomah Cty., 596 F.3d 15 1007, 1015 (9th Cir. 2010). The “clearly erroneous” standard 16 applies if the question is whether there is sufficient evidence 17 to rebut an evidentiary presumption. Garner v. Shier (In re 18 Garner), 246 B.R. 617, 619 (B.A.P. 9th Cir. 2000) (superseded by 19 statute in part on unrelated grounds). A finding is “clearly 20 erroneous” when although there is evidence to support it the 21 reviewing court is left with a definite and firm conviction that 22 a mistake has been committed. Anderson v. Bessemer City, 470 23 U.S. 564, 573 (1985). But a ruling is not clearly erroneous 24 unless it is illogical, implausible or without support in the 25 26 7 Neither party has disputed this court’s authority to enter a “final” 27 decision on this objection and so they have consented to this court doing so. 28 mB au tt, t ei r,f ti ht isi s md ee mt oe rr am ni dn ue md it sh i ts h ec o cu or ut r tc ’a sn n fo it n de in nt ge sr oa f f fi an ca tl ad ne dc i cs oi no cn l ui sn i ot nh si s o f law. 1 record. Ezra v. Seror (In re Seror), 537 B.R. 924, 929 (B.A.P. 2 9th Cir. 2015). 3 After a brief overview of the claims process and whether 4 3MB has overcome an initial evidentiary burden, the court will 5 review whether the default interest provisions here require 6 scrutiny as liquidated damages. The court will then 7 alternatively apply a liquidated damages analysis. 8 9 1. 3MB has the burden of proof 10 “A proof of claim executed and filed in accordance with 11 [the Federal Rules of Bankruptcy Procedure] shall constitute 12 prima facie evidence of the validity and amount of the claim.” 13 Federal Rule of Bankruptcy Procedure 3001(f).8 This evidentiary 14 burden is rebuttable. Litton Loan Servicing, LP v. Garvida (In 15 re Garvida), 347 B.R. 697, 706 (B.A.P. 9th Cir. 2006). “If the 16 objector produces sufficient evidence to negate one or more of 17 the sworn facts in the proof of claim, the burden reverts to the 18 claimant to prove the validity of the claim by a preponderance 19 of the evidence.” Ashford v. Consol. Pioneer Mortg. (In re 20 Consol. Pioneer Mortg.), 178 B.R. 222, 226 (B.A.P. 9th Cir. 21 1995). But if the objecting party does not rebut the 22 presumption, the claims litigation ends there; the claim should 23 be allowed without the claimant bearing any further burden to 24 demonstrate the validity of its claim. Lundell v. Anchor Constr. 25 Specialists, Inc., 223 F.3d 1035, 1041 (9th Cir. 2000). 26 27 8 Unless specified otherwise, all chapter and section references are to 28 t Fh ee d eB ra an lk r Ru up lt ec sy oC fo d Be a, n k1 r1 u pU t. cS y. C P. r o§ c§ e d1 u0 r1 e- a1 n5 d3 2 a. l l A “l Cl i v“ iR lu l Re u” l er ”e f re er fe en rc ee ns c ea sr e a rt eo tt oh e the Federal Rules of Civil Procedure. 1 This objection presents an interesting twist on the usual 2 burden of proof. The debtor here is raising defenses to 3 allowance of a provision in a promissory note. See §558. U.S. 4 Bank complied with the requirement of Rule 3001 here and amended 5 its claim as well. So, the initial burden is on the debtor to 6 negate an element of the claim. But the debtor here is not 7 challenging the elements of the claim — just the enforceability 8 of a component of the claim. So, the court must determine if 9 the affirmative defenses have been established by the debtor 10 rather than analyze whether the claim itself is supported by 11 sufficient evidence. 3MB’s burden is the same and so is U.S. 12 Bank’s - they just arise differently than standard claim 13 litigation. So, for our purposes, the debtor’s affirmative 14 defenses must be reviewed. We are passed the allowance of the 15 claim and examine only one of the claim’s components. 16 17 2. The default interest provision is not liquidated damages 18 Section 506(b) includes in a claim of an over-secured 19 creditor “. . . interest . . . and any reasonable fees, costs, 20 or charges provided for under the agreement . . . under which 21 such claim arose.” The code is silent on the interest rate to 22 be allowed. The Supreme Court in Travelers Cas. & Sur. Co. of 23 Am. v. PG&E, 549 U.S. 443, 450 (2007) affirmed that 24 “[c]reditors’ entitlements in bankruptcy arise in the first 25 instance from the underlying substantive law creating the 26 debtor’s obligation, subject to any qualifying or contrary 27 provisions of the Bankruptcy Code.” The Ninth Circuit “read(s) 28 Travelers to mean the default rate should be enforced, subject 1 only to the substantive law governing the loan agreement, unless 2 a provision of the Bankruptcy Code provides otherwise.” GE 3 Capital Corp. v. Future Media Prods., 536 F.3d 969, 973 (9th 4 Cir. 2008) (“GECC”). In reviewing a bankruptcy courts’ 5 disallowance of default interest as a component of GECC’s payoff 6 demand in an asset sale, the Ninth Circuit remanded the case so 7 the trial court could determine whether the rate was 8 unenforceable under applicable non-bankruptcy law subject to 9 “equities involved in [the] bankruptcy proceeding.” Id. at 974 10 (quoting In re Laymon, 958 F.2d 72, 75 (5th Cir. 1992) cert. 11 denied, 506 U.S. 917 (1992). California law applies here. So, 12 the next question is whether substantive California law prevents 13 enforcement of default interest under this Note. 14 California law allows a creditor to recover default 15 interest from a borrower. Flojo Internat., Inc. v. Lassleben, 4 16 Cal. App. 4th 713, 721 (1992) [subrogated guarantor entitled to 17 enforce default interest]; San Paolo United States Holding Co. 18 v. 816 S. Figueroa Co., 62 Cal. App. 4th 1010 (1998) [trial 19 court directed to recalculate deficiency balance after judicial 20 foreclosure, including interest at default rate]. GECC places 21 the burden on the debtor to demonstrate the default rate is 22 unreasonable or unenforceable under non-bankruptcy law. Wells 23 Fargo Bank, N.A. v. Beltway One Dev. Grp., LLC (In re Beltway 24 One Dev. Grp., LLC), 547 B.R. 819, 830 (B.A.P. 9th Cir. 2016). 25 3MB has not met the burden here. First, default interest 26 following note maturity has long been allowed in California 27 without resort to a liquidated damages analysis. In Thompson v. 28 Gorner, 104 Cal. 168 (1894) the California Supreme Court upheld 1 a default interest provision under a note which was triggered 2 upon maturity. Id at 170. In Thompson, the note matured but the 3 non-default rate was paid in payments thereafter and accepted by 4 the lender. When the lender finally refused to accept the late 5 payments, it sought the full amount due with interest at the 6 default rate. The court held the default rate was bargained 7 for, but the lender waived its application for the period it 8 accepted the payments. The default rate — 1% per month — was 9 allowed thereafter.9 10 The California Supreme Court’s decision in Garrett v. Coast 11 & S. Fed. Sav. & Loan Ass’n., 9 Cal. 3d 731 (1973) (superseded 12 by statute on irrelevant grounds, see Walker v. Countrywide Home 13 Loans, Inc., 98 Cal. App. 4th 1158, 1171 (2002)) did not 14 overrule or significantly limit Thompson concerning matured 15 notes. Garrett reviewed a demurrer to a class action complaint 16 where the class was obligors under notes secured by deeds of 17 trust. Late charges were assessed by the lender on the entire 18 unpaid balance if there was a payment default. The court held 19 that late charges based on the entire unpaid balance for failure 20 to pay an installment was punitive and was not rationally 21 calculated to merely compensate the injured lender. Id. at 740. 22 Garrett specifically distinguished Thompson noting that at 23 maturity, the borrower in Thompson “owed only what he had 24 contracted to pay had there been no default, the principal 25 amount plus accrued interest. If these amounts were not then 26 paid the parties agreed that interest at the higher rate would 27 9 A version of Cal. Civ. Code § 1671 (liquidated damages) was enacted in 28 1 18 97 72 7, , b ee ff fo er ce t iT vh eo m 1p 9s 7o 8n , w ea ss t ad be lc ii sd he id n. g pT rh ea st u ms pt ta it vu et e v ah la is d ib te ye n o fa m le in qd ue id d ao tn el dy do an mc ae g ei n clauses in commercial contracts. 1 accrue.” Garrett, 9 Cal. 3d. at 849. That is precisely the 2 situation here. 3MB failed to pay the “balloon” at maturity and 3 default interest began to accrue. Thompson more closely mirrors 4 this situation; not Garrett.10 5 Second, the default interest charged here is not a penalty. 6 “A default rate of interest should not be a penalty. Rather, it 7 should be a means for compensating the creditor for any loss 8 resulting from the nonpayment of principal at maturity.” In re 9 DWS Invest., Inc., 121 BR 845, 849 (Bankr. C.D. Cal. 1990) [25% 10 not approved because it “seem[ed] excessive” and no evidence 11 presented justifying the rate other than it was equal to what 12 was charged in other transactions]. 13 [T]he general rule for whether a contractual condition 14 is an unenforceable penalty requires the comparison of 15 (1) the value of the money or property forfeited or transferred to the party protected by the condition to 16 (2) the range of harm or damages anticipated to be caused that party by failure of the condition. If the 17 forfeiture or transfer bears no reasonable 18 relationship to the range of anticipated harm, the condition will be deemed an unenforceable penalty. 19 20 Grand Prospect Partners, L.P. v. Ross Dress for Less, Inc., 232 21 Cal. App. 4th 1332, 1358, as modified on denial of reh’g (Feb. 22 9, 2015). 23 The facts here favor a finding of no penalty. U.S. Bank 24 presented the testimony of their expert, Cynthia Nelson. She 25 testified (by declaration) without contradiction that the value 26 10 The distinction between liquidated damage and “alternative performance” contractual provisions was more recently illustrated in McGuire 27 v. More-Gas Invs., LLC, 220 Cal. App. 4th 512, 522-23 (2013) [summary 28 rj au td ig om ne an lt cr he ov ie cr es ”e d c ow uh le dn bf ea c mt as d ew e wr he e nn o vt i ep wr ee ds e an tt e td h es ho tw ii mn eg tt hh ea t c o“ na t rr ae ca tl i ws at si c and made]. 1 of the loan is seriously compromised since now the loan no 2 longer conforms to its expected duration. So, U.S. Bank is 3 damaged and has higher costs and expenses including the use of a 4 special servicer to enforce the now matured loan. Both Nelson 5 and U.S. Bank’s other witness, Nikula, noted that the 4% 6 interest charge in addition to the note rate is well within the 7 range in similar commercial loans and that was the case when 3MB 8 signed the Note. Also, the small percentage that the accrued 9 balance of default interest is compared to the balance of the 10 loan supports that the charge here is reasonable. There is no 11 contrary evidence that the charge here bears no relationship to 12 the harm U.S. Bank currently experiences or would have at the 13 inception of the loan. Bell opines in his declaration that U.S. 14 Bank will recover all its’ “costs” without the default interest 15 provision because of the center’s value and potential future 16 cash flow. Assuming Bell is correct — ignoring the speculation 17 — there is no contrary testimony on the impact on the value of 18 the loan unpaid on maturity. 19 Third, application of the default interest provision in 20 this case is equitable. 21 The power to modify the contract rate [of interest] on 22 notions of equity should be exercised sparingly and limited to situations where the secured creditor is 23 guilty of misconduct, the application of the 24 contractual interest rate would harm the unsecured creditors or impair the debtor’s fresh start or the 25 contractual interest rate constitutes a penalty. 26 27 In re 785 Partners LLC, 470 B.R. 126, 134 (Bankr. S.D.N.Y. 2012) 28 (citing Urban Communicators PCS Ltd. P’ship v. Gabriel Capital, 1 Ltd. P’ship, 394 B.R. 325, 338 (S.D.N.Y. 2008)). No court has 2 adopted a bright line rule that the contract rate should be 3 refused in all insolvent debtor cases. “Most Chapter 11 cases 4 involve insolvent debtors, and such an exception would swallow 5 up the rule that the over secured creditor is presumptively 6 entitled to the ‘contract rate.’” In re Residential Capital, 7 LLC, 508 B.R. 851, 858 (Bankr. S.D.N.Y. 2014) (quoting In re 8 Madison 92nd Street Assocs. LLC, 472 B.R 189, 200 n. 7 (Bankr. 9 S.D.N.Y. 2012)). There is no allegation or proof here that U.S. 10 Bank or its’ predecessors are guilty of misconduct. The court 11 has determined the default interest here is not a penalty for 12 the reasons stated. So, the question here is harm to unsecured 13 creditors and impairing the debtor’s fresh start. 14 There are three unsecured creditors in this case.11 Two are 15 insiders with substantial claims. The third — not an insider — 16 has a much smaller claim. True enough, insider claims are 17 allowed unsecured claims absent objection. But here, solvency 18 is inconclusive.12 The debtor claims the shopping center has 19 $3.0 million in “equity;” U.S. Bank claims there is about 20 $500,000.00 of “equity.” So, without a conclusive finding of 21 value, the unsecured creditors will either receive full payment 22 or something less. Even at the lower value, the fact the 23 unsecured creditors may not receive their full claim does not 24 make the default interest charged here inequitable. Unsecured 25 11 There are two personal injury claims disputed by the debtor. One is apparently covered by insurance; the other may be but there are other 26 defendants in the underlying personal injury litigation. Neither claimant has filed a claim. 27 12 At the hearing on this motion, there was a suggestion that this 28 d ne ob tt o mr a ki in n gp o ts hs ae ts s fi io nn d ii ns g .c u r Ar se n wt il ly l a bd em i sn ei es n,tr a tt hi av te l wy o ui ln ds o nl ov te n ct o. n t rT oh le tc ho eu rt is equitable analysis. 1 creditors often receive less than their full claims in a 2 bankruptcy case. Also, the unsecured creditors have received 3 many benefits in this bankruptcy including: staying the 4 appointment of a receiver; over one year of 3MB’s continued 5 operation instead of foreclosure; freedom for 3MB to litigate 6 pending eminent domain cases; the opportunity to vote on the 7 proposed plans. On balance, the treatment of unsecured 8 creditors does not mandate disallowance of the claim. 9 Impairment of “the fresh start” is undefined by the debtor 10 here. Bell’s declaration concludes the payment of the default 11 interest will have a “negative impact” on reorganization. How? 12 No quantifiable basis for the conclusion is included in the Bell 13 declaration. The debtor has not met the burden on that issue. 14 Debtor’s other reasons why default interest in this case is 15 inequitable are similarly unsupported. The fact debtor made all 16 payments under the loan before maturity does not mean default 17 interest is inequitable. The debtor performed the contract 18 through maturity which is what is expected of parties to a 19 contract. The same is true of the debtor’s performance under 20 the cash collateral order. The debtor was ordered to make the 21 payments and otherwise perform. Default interest is not a 22 windfall for U.S. Bank. Not only is the default interest under 23 the Note within the acceptable range for similar commercial 24 loans according to the undisputed testimony, disallowed default 25 interest could be a “windfall” for equity in this case if the 26 shopping center’s value is what the debtor claims. The terms of 27 the loan were known when it began. Absent inequitable conduct 28 by U.S. Bank or its’ predecessors, this court cannot ignore the 1 terms of the loan for equitable reasons. Finally, debtor’s 2 speculation that U.S. Bank will be paid in full (except default 3 interest) from cash flow in the future does not suggest default 4 interest is inequitable. The loan matured two–and-one-half 5 years ago. The testimony offered by U.S. Bank bears out the 6 harm that is actually occurring to the value of the loan. 7 3MB contends Foss v. Boardwalk Partners (In re Boardwalk 8 Partners), 171 B.R. 87 (Bankr. D. Ariz. 1994) supports a finding 9 that default interest is inequitable. A close reading shows 10 otherwise. There, the court examined secured creditor claims to 11 property sale proceeds. After authorizing disbursement of the 12 principal owed the lienholders, the court reviewed the default 13 interest claims. But in Boardwalk Partners, the court noted no 14 effort by the lienholders to justify the default interest rate 15 and the contract rate was above market when the loan was made. 16 Id. at 92-93. The Boardwalk Partners court considered earlier 17 cases noting the courts “implicitly examined” the reasonableness 18 of the interest rate. Id. at 92. Holding the default rate 19 (14.5%) was unreasonable, the Boardwalk Partners court did not 20 hold the equities would always support disallowing default 21 interest. 3MB here provided no evidence the interest rate was 22 unreasonable or unconscionable, but U.S. Bank presented evidence 23 the default interest rate was neither. 24 The court concludes, then, that based on the evidence 25 presented and the terms of the Note, the default interest 26 provision is enforceable and need not be examined under the 27 liquidated damages rubric. The clause involved here is a valid 28 “alternative performance” and is not a penalty under California 1 law. Since the issue is close, the court will now examine the 2 default interest provision as liquidated damages. As will be 3 seen, this leads to the same conclusion. 4 5 3. Alternatively, the default interest provision is a valid 6 liquidated damages clause. 7 The validity of a liquidated damages clause in a commercial 8 contract is governed by Cal. Civ. Code § 1671(b), which 9 provides: 10 Except as provided in subdivision (c), a provision in 11 a contract liquidating the damages for the breach of the contract is valid unless the party seeking to 12 invalidate the provision establishes that the 13 provision was unreasonable under the circumstances existing at the time the contract was made. 14 15 The adverse party, here 3MB, has the burden of proving that the 16 clause was unreasonable. The current section “liberalizes” the 17 availability of liquidated damages in non-consumer contract 18 cases. Ridgley v. Topa Thrift & Loan Ass’n, 17 Cal. 4th 970, 19 977 (1998). This, in part, is how liquidated damages clauses 20 are more available in commercial contracts. Id. 21 The amount of damages U.S. Bank or its predecessors 22 actually incurred is irrelevant to the reasonableness of the 23 liquidated damages clause. Instead, the validity of the clause 24 depends on “its reasonableness at the time the contract was made 25 and not as it appears in retrospect.” Law Revision Commission 26 Comments to Cal. Civ. Code § 1671 (Deerings). The Commission 27 also lists typically relevant circumstances in the 28 reasonableness inquiry: 1 • Relationship that the damages provided in the contract 2 bear to the range of harm that reasonably could be 3 anticipated at the time of making the contract. 4 • Relative equality of the bargaining power of the 5 parties. 6 • Whether the parties were represented by lawyers when 7 the contract was made. 8 • Anticipation of the parties that proof of actual 9 damages would be costly and inconvenient. 10 • The difficulty of proving causation and 11 foreseeability. 12 • Whether the liquidated damages provision is included 13 in a form contract. 14 Id. 15 Ridgley focuses these factors into a two-pronged inquiry. 16 3MB must establish that the default interest provision “bears no 17 reasonable relationship to the range of actual damages that the 18 parties could have anticipated would flow from a breach.” 19 Ridgley, 17 Cal. 4th at 977. Also, the parties must also have 20 failed to make a “reasonable endeavor” to estimate the fair 21 average compensation for any loss that may be sustained. Id. 22 The court now examines these two issues in order. 23 A. The evidence establishes the reasonable relationship to 24 anticipated actual damages. 25 3MB claims the value of the shopping center when the loan 26 was made was enough to cover any loss experienced by the lender 27 upon default or foreclosure. The second “earnout” loan is, 28 according to 3MB, evidence of U.S. Bank’s predecessor’s comfort 1 with their collateral position. So, 3MB contends, the default 2 interest is not reasonably related to actual loss when the 3 contract was made. To be sure, there may have been equity 4 protecting Prudential’s position then but alternative 5 “protections” available to a party upon inception of the 6 contract is not the relevant test. The issue is whether there 7 is a reasonable relationship between the default interest and 8 actual damages. The evidence here supports U.S. Bank. 9 First, both Nikula and Nelson testified that the four 10 percent increase over the “Note Rate” is consistent with similar 11 commercial loans. Nelson testified that four percent is a 12 reasonable damage estimate at the loan’s inception based on the 13 harm anticipated upon default. This is bolstered by the fact 14 default interest is standard in commercial mortgage backed 15 security transactions. Nelson explained the initial pricing of 16 the loan reflected full payment at maturity and the increased 17 risk to full recovery when the loan was not paid support the 18 reasonableness of default interest provision. This testimony is 19 uncontradicted. 20 Second, the language of the Note itself cannot be ignored. 21 The Note in part states: 22 Borrower acknowledges that it would be extremely 23 difficult or impracticable to determine Lender’s 24 actual damages resulting from any late payment, Event of Default or prepayment, and the late charges, 25 default interest and prepayment fees, premiums, fees and charges described in this Note are reasonable 26 estimates of those damages and do not constitute a 27 penalty. 28 1 When the Note was signed, 3MB acknowledged (a) the difficulty in 2 determining actual damages and (b) default interest (is) a 3 reasonable estimate of the damages. These are facts 4 conclusively presumed as between 3MB and Prudential (now U.S. 5 Bank) when the Note was made and not recitals of consideration. 6 Cal. Evidence Code § 622; Federal Rule of Evidence 302.13 So, 7 most of the pre-requisites to a valid liquidated damages clause 8 are conclusively presumed to exist here. 9 Third, the remaining relevant conditions for a valid 10 liquidated damages clause are present. Both parties (Prudential 11 and 3MB) had counsel when the Note was signed. Though 12 Prudential is a sophisticated lender, 3MB’s principals were and 13 are sophisticated borrowers. There is uncontradicted testimony 14 that when the Note was made, the default interest component of 15 the Note was within the range of expected damages the lender 16 would experience in the event of default. The Note does appear 17 almost identical with the other notes submitted to the court as 18 evidence of the relevant transactions, but the court is not 19 convinced the similar language makes the Note a “form contract.” 20 In sum, the “factors” establish that, on balance, the default 21 interest provision involved here is a valid liquidated damages 22 clause. 23 24 13 The presumption is inapplicable if: there is a lack of arm’s length negotiations; the contract is an adhesion contract; or the contract is 25 invalid. See City of Santa Cruz v. PG&E, 82 Cal. App 4th 1167, 1176-77 (2000) and Bruni v. Didion, 160 Cal. App. 4th 1272, 1291 (2008). None of 26 those conditions exist here. But cf. Stoneridge Parkway Partners, LLC v. MW Housing Partners III, L.P., 153 Cal. App. 4th 1373, 1382-83 (2007) [holding 27 the presumption was inapplicable to a recital related to an interest 28 p ar go rv ei es mi eo nn t s ii nn dc ie s pi ut t aw ba ls y a “ dr ie dc i nt oa t l co of m pc oo rn ts i wd ie tr ha t ei io tn h era n pd a rt th ye ’ ss ta it ne tm ee nn tt is o ni n o rt he understanding of the transaction.”] 1 Fourth, the cases holding otherwise relied upon by 3MB are 2 distinguishable. An invalid liquidated damage clause was found 3 when the proponent of the clause provided no evidence that the 4 default rate was reasonably related to increased risk. Cal. 5 Bank & Tr. v. Shilo Inn, Seaside E., LLC, No. 3:12-CV-00506-HZ, 6 508, 509, 2012 U.S. Dist. LEXIS 163134 (D. Or. Nov. 15, 2012). 7 Here, there is evidence about the risk and the court in Shilo 8 Inn did not hold default interest could not be considered 9 compensation for increased risk. In re 8110 Aero Drive 10 Holdings, LLC, No. BR 16-03135-MM11, 2017 WL 2712961 (Bankr. 11 S.D. Cal. May 8, 2017) is also distinguishable. There the court 12 noted the risk of the loan itself was the primary factor in the 13 unknown costs alleged by the lender to support default interest. 14 Id. at *10. Here, the value of the loan was anticipated to be 15 compromised if unpaid at maturity. In 8110 Aero Drive, the loan 16 had not matured, and the court found that 151% of the value of 17 the missed payments was a disproportionate charge compared to 18 the lender’s loss and thus a penalty. Id. at *12-*13. Those 19 facts are not present here. The uncontradicted testimony is the 20 default interest accrued is a small percentage of the loan 21 balance. 22 Other cases 3MB relies upon, on close reading, do not help 23 its’ position. Morris v. Redwood Empire Bancorp, 128 Cal. App. 24 4th 1305, 1314-15 (2005) held a “termination fee” charged a 25 merchant under a credit card agreement was not a liquidated 26 damage clause but a form of alternative performance since the 27 fee was not triggered by a breach of contract. In El Centro 28 Mall, LLC v. Payless ShoeSource, Inc., 174 Cal. App. 4th 58 1 (2009), the court of appeal affirmed a trial court ruling 2 finding a liquidated damage provision in a lease was not a 3 penalty. In El Centro Mall there was evidence suggesting the 4 amount charged was arbitrary but there was contrary evidence 5 which the trial court found persuasive. There is evidence 6 supporting the reasonableness of the clause in this case which 7 this court has already found persuasive.14 8 9 B. The “reasonable endeavor” prong has been met here. 10 3MB argues that when the Note was negotiated there were no 11 discussions about why default interest provisions were contained 12 in the Note or any estimation of damages if there was a default. 13 First, the conclusive presumption discussed above means the 14 discussions, if any, are irrelevant. 15 Second, even if the presumption was inapplicable, the 16 validity of a liquidated damages clause does not depend on 17 actual negotiation over its provisions. “[T]he reasonable 18 endeavor test does not require both parties to a form contract 19 to expressly negotiate the amount of liquidated damages.” Util. 20 Consumers’ Action Network v. AT&T Broadband of S. Cal., Inc., 21 135 Cal. App. 4th 1023, 1035 (2006). See also Lowe v. Mass. 22 Mut. Life Ins. Co., 54 Cal. App. 3d 718, 735-38 (1976) [“not 23 necessary for the prospective lender to review all of its 24 possible damages with the assignor” — standby deposit retained 25 by lender under lender’s funding commitment]. Rather, the focus 26 is on the motivation and purpose in imposing the charges and 27 28 the liq14 u iT dh aa tt e ds a di ad m, a gt eh se wE al s C ae n pt er no a lM ta yl l b ec co au ur st e d oi fd oh to hl ed r t lh ea at s eo n pe r oc vo im sp io on ne sn t of applicable upon the tenant’s default. Id. at 64. 1 |/their effect. Utility Consumers’ Action Network, 135 Cal. 2 ||App.4th at 1029. 3 The evidence here is the extent of losses the lender would 4 ||suffer upon default were unknown or at least not quantifiable 5 |}when the Note was signed. The diminished loan value and the 6 ||increased costs were anticipated but the extent of loss was not. 7 ||Instead, the Note provided for default interest well within 8 ||market standards for commercial contracts. There is no evidence 9 ||3MB was unaware that the lender would incur losses if the Note 10 not retired when due or otherwise was in default. There is 11 evidence the default interest rate had no relationship to the 12 |janticipated loss; in fact, it is to the contrary. Since the 13 |idefault interest charge appears reasonable and does not have as 14 primary purpose to serve as a threat to compel compliance, 15 |/the clause at issue is a reasonable endeavor to estimate the 16 |} lender’s losses in event of default. Consequently, the default 17 |jJinterest provision here is an enforceable liquidated damages 18 ||}clause. 19 20 CONCLUSION 21 For the foregoing reasons, the objection to allowance of 22 |}U.S. Bank’s claim is OVERRULED. A separate order shall issue. 23 24 35 Dated: Dec 05, 2019 By the Court 26 , a ) : Zr ort streto II, Judge 28 United States Bankruptcy Court 23 1 Instructions to Clerk of Court 2 Service List - Not Part of Order/Judgment 3 The Clerk of Court is instructed to send the Order/Judgment 4 or other court generated document transmitted herewith to the 5 parties below. The Clerk of Court will send the Order via the BNC or, if checked X , via the U.S. mail. 6 7 3MB, LLC 8 1201 24th Street, Suite B-210 Bakersfield CA 93301 9 Office of the U.S. Trustee 10 United States Courthouse 11 2500 Tulare Street, Room 1401 Fresno CA 93721 12 Amir Gamliel 13 1888 Century Park E #1700 14 Los Angeles CA 90067 15 David M. Neff 16 1 IBM Plaza Chicago IL 60611 17 Leonard K. Welsh 18 4550 California Ave 2nd Fl 19 Bakersfield CA 93309 20 21 22 23 24 25 26 27 28