Reported / Citable
Background
Lakeshore Investment loaned NOW Solutions about $1.76 million, secured by intellectual property. After years of defaults and amended payment schedules, Lakeshore sued for breach. The parties eventually settled: NOW promised to pay $450,000, but a default would permit entry of a $1.5 million judgment plus interest.
NOW defaulted, and the trial court enforced the $1.5 million amount. On appeal, NOW argued that the clause was not a valid estimate of damages but an unlawful contractual penalty. The record described extensive arm’s-length negotiations but did not show how the parties connected the default amount to anticipated harm from breaching the settlement.
The Court’s Holding
A divided Second District reversed. California permits liquidated damages—a sum fixed in advance as a reasonable estimate of hard-to-measure loss—but not a penalty designed principally to compel performance. With no evidence that both sides reasonably endeavored to estimate loss, a $1.5 million consequence for failure to pay $450,000 bore no reasonable relationship to anticipated settlement-breach damages.
The majority held that NOW carried its burden because the stipulated amount was more than three times the settlement obligation and the asserted considerations were not documented as part of the parties’ estimate. It directed the trial court to determine actual damages. Justice Wiley dissented, emphasizing sophisticated parties, the borrower’s history, collection risk, and freedom of contract.
Key Takeaways
- A settlement default provision must reasonably estimate damages from breach of the settlement itself.
- A large stipulated judgment is vulnerable when the record does not explain the calculation.
- Arm’s-length negotiation and sophisticated counsel do not alone transform a penalty into liquidated damages.
- Drafting should document the anticipated losses, collection risks, delay costs, and methodology supporting the amount.
- Invalidating the clause does not erase the breach; the creditor may still recover proven actual damages.
Why It Matters
The opinion is a warning against the familiar structure in which a debtor agrees to a discounted payment while authorizing a much larger judgment upon any default. Courts will examine the proportionality and evidentiary basis of the larger amount, even when commercial parties knowingly signed the deal.
Settlement counsel should build the reasonableness record when negotiating—not for the first time in enforcement litigation. Recitals can identify uncertainty, expected collection expense, lost use of funds, and other reasonably anticipated harm, while the amount should reflect that analysis. Creditors may also use acceleration, interest, security, and carefully calibrated remedies that protect performance without appearing punitive.