Honchariw: The Enforceability of Late Fees in California

A recent California decision provides clarity on a lender’s ability to charge late fees for missed loan payments, which should be of interest to all lenders operating in California.

In Honchariw v. FJM Private Mortgage Fund, LLC, et al.,[1] the California First District Court of Appeals held that late payment fees assessed against the entire unpaid principal balance of a loan constitutes unlawful penalties under California Civil Code Section 1671. In Honchariw, two borrowers received a $5.6 million commercial loan, secured by a deed of trust. When the borrowers missed a monthly installment payment, they triggered two late-payment fees under the loan: (i) a one-time 10% fee assessed on the overdue payment, and (ii) a default interest rate of 9.99% imposed against the entire unpaid principal balance of the loan. The borrowers challenged the fees in arbitration, but their claims were denied. On appeal, the borrowers argued that the imposition of the default interest rate against the entire unpaid balance of the loan violated California Civil Code Section 1671.

Under Section 1671, liquidated damages provisions are presumptively valid in non-consumer contracts, provided that the provisions are not determined to be unreasonable.[2] The Honchariw court noted that, to be reasonable, liquidated damages must “bear a ‘reasonable relationship’ to the [lender’s] actual damages.”[3] Alternatively, late fees are unreasonable and unenforceable when used to coerce payment by imposing “charges bearing little or no relationship” to the lender’s actual losses.[4] Citing California Supreme Court precedent, the court held that charges incurred for missed payments, but assessed against the entire unpaid principal balance of the loan, are “punitive in character”[5] and not aimed at compensating the lender for its loss. Ultimately, the Honchariw court held that the late-payment fees imposed by the lender violated Section 1671 and public policy because the fees were leveled against the entire unpaid balance of the loan, despite the borrowers only missing one payment.[6]

Lenders making commercial loans in California should be aware that, if challenged, late fees imposed against the entire unpaid principal balance of a loan may be deemed unenforceable penalties. Under the Honchariw ruling, late fees must be reasonably related to the actual costs and expenses incurred by a lender as a result of missed payments. Notably, nothing in Honchariw purports to preclude a lender from charging fees against amounts already due under the loan, including the late installment.