Stipulated judgment for more than settlement amount is invalid

May parties to a settlement agree that plaintiff will accept a lesser sum if timely paid by defendant, while also providing for entry of a stipulated judgment for a larger amount if defendant defaults? After all, isn't the reduced amount merely a permissible discount if defendant pays the debt as agreed? Apparently not, according to a recent state appellate court decision, Vitatech International, Inc. v. Sporn, 2017 DJDAR 10381.

Although the clause used in Vitatech is commonly inserted in settlement agreements, especially where the defendant is making payments over time, Vitatech's holding is a stark reminder that such a provision may be an impermissible penalty that will not be enforced. To render such a clause enforceable, great care must be taken to comply with the requirements of Civil Code Section 1671(b) as to liquidated damages.

The Vitatech Case

Vitatech International, Inc. sued three defendants, seeking approximately $166,000 for breach of contract after defendants failed to pay invoices for products they purchased from Vitatech. On the eve of trial, the parties settled for a one-time payment of $75,000. They also entered into a stipulation for entry of judgment "in the full prayer of the Complaint," but Vitatech agreed to "forbear" from filing the stipulation and to accept the $75,000 "as full Settlement of its claims against Defendants" if they paid by the designated date. After defendants failed to pay, Vitatech filed the stipulation. The trial court entered judgment against defendants for $303,620.12, including $166,372.14 in compensatory damages, $104,427.01 in prejudgment interest, $28,315.00 in attorney fees (even though the stipulation lacked an attorney fee provision), and $4,505.97 in costs.

Defendants moved to vacate the judgment under Code of Civil Procedure Section 473(d), arguing that it was void because it constituted an unlawful penalty and bore no reasonable relationship to the damages likely to be caused by the breach of the settlement agreement. Denying the motion, the trial court agreed with Vitatech -- the judgment was not a penalty or illegal liquidated damages provision because defendants judicially admitted and stipulated to their liability in the full amount of the complaint's prayer, and the stipulated judgment merely enforced that acknowledgement. It was simply a discount of the agreed-upon liability to encourage prompt and timely payment.

Citing its earlier decision in Greentree Fin. Group, Inc. v. Execute Sports, Inc., 163 Cal. App. 4th 495 (2008), the appellate court reversed the trial court. Generally, California law has viewed liquidated damages after breach of contract as a forfeiture thereby rendering void that part of the contract. Civil Code Section 1671 continues to apply that strict standard to liquidated damages clauses in certain contracts (consumer goods and services, and leases of residential real property). However, as to commercial and business contracts, the law is more liberal: "[A] provision in a contract liquidating the damages for 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." Section 1671(b).

Liquidated damages are generally considered not enforceable and viewed as a penalty under Section 1671(b) if they bear no reasonable relationship to the range of actual damages that the parties could have anticipated would flow from a breach. The defining feature is the lack of proportional relation between the penalty and the damages that may actually result from the breach. Where no proportional relation exists, the wronged-party may recover only the actual damages sustained.

Here, the stipulated judgment, four times the settlement amount, was an unenforceable penalty. It was void as a matter of law because no reasonable relationship existed between the damages that could have been anticipated based on defendants failure to pay the $75,000 settlement amount and the stipulated judgment for more than $300,000. No evidence was presented to demonstrate the damages Vitatech incurred as a result of the breach, nor did defendants expressly admit liability on the underlying claims. The language in the stipulation did not constitute an admission of liability for breach of the underlying contract nor did it constitute an admission of the amount of damages caused by the breach. Rather, the verbiage was simply an agreement to settle a disputed claim for less than the amount demanded and a penalty if defendants failed to timely pay the settlement amount.

Based on this reasoning, the appellate court reversed the order denying defendants' motion to vacate the stipulated judgment and remanded with directions for the trial court to grant the motion and enter a new judgment for $75,000 based on the parties' stipulation for entry of judgment. Since the stipulation did not include a provision for attorney fees or prejudgment interest, Vitatech was only entitled to trial court costs.

Practice Pointers

What can be gleaned from this case when drafting a settlement agreement that will include a stipulation for entry of judgment in the event of default? For starters, the stipulation should include an attorney fee provision, "in the event of default, plaintiff would be entitled to recover reasonable attorney fees and costs in entering the judgment." The stipulation should also provide for interest at the legal rate (10 percent) from the date of default.

Because the Vitatech opinion emphasized the lack of an admission of liability by defendants, inclusion of such language would be prudent. For example, the settlement agreement would reflect the larger sum -- for which defendant would expressly admit liability -- and plaintiff would agree to accept the lesser sum if payment is timely made. In the event of default, the stipulation should provide for entry of judgment for the larger amount, to reflect the time-value of money, plus attorney fees, pre-judgment interest from date of breach, and cost. Obviously, the delta between the larger and lesser sums must bear some proportional relationship to the actual damages plaintiff will incur in the event breach.

Conclusion

Vitatech provides a cautionary tale in drafting a stipulation for entry of judgment. However, it also instructs on how to include language that complies with the restrictions on liquidated damages. By adhering to these guidelines, parties may draft an enforceable stipulation for entry of judgment, one that provides incentive to the defendant to timely pay the discounted amount, while also giving the plaintiff some comfort in knowing that an adequate judgment will be entered in the event of default.