Ridgley v. Topa Thrift and Loan Association

ROBERT M. RIDGLEY, et al., Plaintiffs and Appellants, v. TOPA THRIFT AND LOAN ASSOCIATION, Defendant and Appellant.
No. B088215 (Super. Ct. No. BC 080477) California Court of Appeal Second Appellate District Division Seven Filed March 27, 1997
        APPEALS from a judgment of the Superior Court of Los Angeles County.
Victor E. Chavez, Judge. Reversed with directions.

        Nebenzahl Kohn Davies & Leff, Randall S. Leff and Gerald S. Frim for Defendant and Appellant.

        Lewitt, Hackman, Hoefflin, Shapiro, Marshall & Harlan, Richard M. Hoefflin and Jill A. Thomas for Plaintiffs and Appellants.

        Defendant and plaintiffs filed appeals from a judgment awarding plaintiffs $114,622.42 as recovery for a prepayment charge on a loan. The court found the charge constituted an unenforceable forfeiture. Defendant contends the charge was not an unenforceable forfeiture, and plaintiffs contend that court abused its discretion when it awarded them only $45,000 in attorney's fees as the actual request for $80,732 was reasonable and supported by substantial evidence. We reverse with directions to enter judgment for defendant.

FACTUAL AND PROCEDURAL SYNOPSIS
I. Factual Background         Plaintiff Robert M. Ridgley had been an architect and property developer for over 30 years. Plaintiff Marlene Ridgley is his wife. Prior to 1990, Robert had been involved in the designing and building of various commercial and residential projects. Robert had obtained construction loans and permanent financing for a few of those projects, none of which involved a prepayment penalty clause or bridge financing.
        In 1990, as part of Robert's business, he purchased a parcel in Encino ("the Property") in order to build a luxury custom home for speculation and sale. Plaintiffs jointly owned the Property. As of late 1990, the construction was 98 percent complete, and the spec home was on the market for sale. The construction loan was in Robert's name, and he was looking for a bridge loan, i.e., a temporary loan between the construction loan and the permanent loan. A loan broker put Robert in touch with defendant Topa Thrift and Loan Association.
        Robert initially spoke with defendant's representative Abe Lander, who gave Robert a quote of 2.3 million dollars for two years, at two to three points over prime, with a 13 percent floor, and an initial fee of three points. No mention was made of a prepayment penalty clause. The loan was secured by the Property and plaintiffs' residence.
        When Robert received and reviewed the loan document, it had a five year prepayment penalty clause. Robert called Lander, who said he would investigate. The clause provided:

        "Borrower may at any time prepay the outstanding principal balance of this Note in whole or in part; provided, however, Borrower will pay to Lender a prepayment charge of six (6) months' interest at the rate in effect at the time of prepayment on the amount prepaid. Such a prepayment charge will be made whether such prepayments are made voluntarily, involuntarily or upon acceleration of this Note. No such prepayment charge will be made on prepayments made five (5) or more years after the date of this Note."

        Subsequently, Steve Gutman from defendant contacted Robert, and on December 20, advised him of defendant's revised specific terms for the loan -- a two year loan, interest only, with an initial fee of four points and no prepayment penalty after six months. Gutman did not advise Robert that defendant was requesting any other condition to the six month prepayment penalty clause.
        On December 21, 1990, plaintiffs executed a promissory note ("the Note"), assignment of rents and deeds of trust in connection with this transaction. The Note contained an addendum stating:

        "PROVIDED ALL SCHEDULED PAYMENTS HAVE BEEN RECEIVED NOT MORE THAN 15 DAYS AFTER THEIR SCHEDULED DUE DATE, AND FURTHER PROVIDED THAT THERE HAVE BEEN NO OTHER DEFAULTS UNDER THE TERMS OF THIS NOTE OR ANY OTHER NOW EXISTING OR FUTURE OBLIGATION OF BORROWER TO TOPA, THEN NO PREPAYMENT CHARGE WILL BE ASSESSED IF THIS LOAN IS PAID IN FULL AFTER June 21, 1991."

        The addendum was typewritten on the document by defendant before plaintiffs signed it, and no one at defendant explained the specific language to Robert. Robert read the new language and understood it to mean that, provided there were no defaults during the first six months, then after June 21, 1991, he could pay off the loan in full without any prepayment penalty. Robert confirmed his understanding in the margin of his copy of the Note, writing "21 of June" and circling his initial. The reason for that notation was: "That was my cutoff date, and I just wanted to make sure that I was aware of the responsibility I had up to June 21."
        Robert requested that an impound fund be established, via a passbook account, for automatic monthly payments. The first ten payments were automatically made from this account, and when the funds were depleted, Robert timely made the November 21, 1991, payment.
        In late October or November of 1991, Robert contacted John Piper, an executive at defendant, to renegotiate the loan for easier payments. As an accommodation to plaintiffs, starting in December 1991, defendant agreed to change the due date from the 21st to the 1st of each subsequent month. Thus, the December 21 payment became due January 1, 1992. Robert timely made the payment due on January 1 on January 12, 1992, and made no further payment until March 12, 1992.
        During January 1992, a number of people expressed interest in buying the Property. Robert kept defendant apprised of all of the sale activities. During January and February, Robert had on-going discussions with Piper with respect to further modification or extension of the loan as the completed Property had not been sold. By February, the Property was in escrow and scheduled to close in April.
        During the discussions with Piper, Robert never received any notice from defendant that he was allegedly in default, was late, had missed a payment or that defendant was dissatisfied with the loan performance or threatened foreclosure. Robert understood that his relationship with defendant was good throughout the discussions. Piper advised Robert: "That he was working on it. He would let me know," there would be a "readjustment of due date," and "he had gotten or was getting the appraisal."
        On March 3, Piper responded with information about the modification, and confirmed by letter stating:

        "Upon receipt and confirmation by TOPA of the above, TOPA agrees to accept the following payment schedule for the months of March and April, 1992; payments of 19,500 to be received by TOPA no later than March 12, 1992 and April 12, 1992."

        According to respondent, plaintiffs failed to make the February payment on time. Robert claimed he did not make a payment during February because he was relying on the on-going conversations and was awaiting Piper's response regarding readjustment of the payment due date. Robert stated he made the February payment on March 12.
        Robert understood this agreement to be a readjustment of the payment amounts and due dates and that nothing else was required of him. As requested by defendant, Robert provided it with a copy of the escrow instructions and timely made the payment due on March 12.
        Piper testified that these were the only payments required, the March 12 payment was applied to the payment originally due February 1, and the April 12 payment was satisfied at the close of escrow. Although Piper testified that the March 12 payment was a partial payment for February, the court took judicial notice of what the document itself actually said; i.e., the word "partial" did not appear on the agreement.
        Defendant never informed Robert that he was obligated to make any other payments nor did defendant advise Robert that he was in default or owed any other obligation to defendant other than the two payments requested on March 12 and April 12. Defendant did not mention any prepayment penalty.
        Defendant imposed a late charge for the February payment. When Robert informed defendant of Piper's letter of March 4 and the timely payment of March 12, defendant waived the February late charge.
        On March 25, Robert received a computerized payment reminder indicating a late charge for the March payment and requesting the larger March 1 and April 1 payments based on the original payment schedule. In response to Robert's note, defendant also waived the March late charge.
        The Property went into escrow in March, and defendant made a payment demand. Defendant's payment demand was for $2,365,502.74, which included a prepayment charge, demand fee and late charges totalling $114,622.42. Plaintiffs objected to these assessments and requested an audit.
        When escrow closed in early April, plaintiffs prepaid the bulk of the loan balance. After the sale of the Property, there remained a balance of $114,622.42 on the Note. Defendant agreed to and did release the deed of trust on the Property and maintained the $114,622.42 balance as a lien on plaintiffs' house. In December 1992, plaintiffs ultimately paid off this balance, plus accrued interest, when they refinanced their house.

II. Procedural History         On May 6, 1993, plaintiffs filed a complaint for breach of contract, money paid by mistake and fraud. The complaint alleged that defendant had wrongfully assessed the prepayment charge as well as certain late charges.
        Defendant filed a motion for summary judgment/summary adjudication of issues. Just prior to the hearing, defendant offered to tender back the March late charge of $1,515.79. The motion was heard by Judge David Yaffe. Judge Yaffe denied the motion for summary judgment and granted the motion for summary adjudication of the issue eliminating the fraud cause of action. Judge Yaffe found there was a triable issue of fact on the basis that the contract language was ambiguous, ruling:

        "The note itself is ambiguous in that it provides for a 5 year prepayment penalty on a 2 year note, and the addendum is also ambiguous in that it can be reasonably construed to mean that if plaintiffs fully performed their obligations and made no prepayment before 6/21/91, defendant agreed to waive the prepayment penalty and could not thereafter revive it because of subsequent late payments."

        Plaintiffs dismissed defendant Piper. The matter was transferred to Judge Victor Chavez for a court trial. After taking the matter under submission, the court ruled:

        "The Court concludes that the prepayment clause as written by [defendant] was in fact a late charge and a penalty in the nature of an unenforcebable [sic] forfeiture. Judgment therefore is awarded to [plaintiffs] and against [defendant] in the sum of $114,622.42 as reimbursement for the 'prepayment' paid to defendant by plaintiffs as well as any interest thereon paid to defendant."

        The court denied defendant's motion for reconsideration of the judgment. Plaintiffs moved to insert interest and to set the amount of attorney's fees. Judgment was entered awarding plaintiffs the principal sum of $114,622.42, plus interest paid to defendant of $9,650.80, plus interest at the rate of 10 percent through the date of judgment ($20,191.65), plus interest on the improperly assessed late charge ($341.05), attorney's fees of $45,000 and costs of $2,667.30.
        Defendant and plaintiffs filed timely notices of appeal.

DISCUSSION         The court ruled that as written, the prepayment provision was in fact a late charge and a penalty in the nature of an unenforceable forfeiture. Citing Garrett v. Coast & Southern Fed. Sav. & Loan Assn. (1973) 9 Cal.3d 731, 736-740 and Sybron Corp. v. Clark Hosp. Supply Corp. (1978) 76 Cal.App.3d 896, 903, plaintiffs contend the court's ruling was correct. However, as those cases did not involve prepayment penalty provisions, they are inapposite.
        "Early California cases firmly established that a lender may refuse to accept payment of a debt before the debt is due. In the absence of statutory or contractual permission, 'a debtor has no more right to pay off the obligation prior to its maturity date than he does to pay it off after its maturity date.' Therefore, a lender who is willing to accept early payment may extract additional consideration from the borrower in exchange for the privilege of prepayment. California courts have upheld prepayment fees against challenges that they were usurious, and that they constituted unlawful liquidated damages." (Citations omitted.) (Gutzi Associates v. Switzer (1989) 215 Cal.App.3d 1636, 1644.)
        "A clause in a deed of trust providing a 'penalty' or reasonable charge for payment of the principal in whole or in part before maturity is neither a penalty nor a liquidated damage provision. The charge is not imposed for breach of the agreement or for default, but rather for the opposite: performance before the promisor was obligated to perform; and the charge is merely the equivalent of unearned interest. 'The clear import of this provision is to give the borrower an option to either pay the note in the manner contemplated by the contract or to prepay the balance due upon condition that a surcharge be added for the privilege of exercising the option. The clause does not penalize for the "breach of an obligation" as contemplated by [Civil Code] section 1670. No breach is involved in the prepayment transaction, only the exercise of the option given to the debtor for an alternative method of paying the debt.'" (1 Witkin, Summary of Cal. Law (9th ed. 1987) Contracts, § 512, p. 458; see also Pacific Trust Co. TTEE v. Fidelity Fed. Sav. & Loan Assn. (1986) 184 Cal.App.3d 817, 823 ["Except for those prepayment provisions required by statute for certain loans against realty[,] a borrower has no right to prepay a loan, although one may bargain for this right. The lender may agree to give the borrower an option to prepay, but may charge a premium or penalty for exercise of this option to compensate for the anticipated interest payments lost by prepayment." (Citations omitted.)].) ¹
        At times, defendant asserts that plaintiffs voluntarily prepaid their loan. It appears that as defendant made an escrow demand, the prepayment was via acceleration of the Note. (See 4 Miller & Starr, Cal. Real Estate (2d ed. 1989) § 9:79, pp. 232-236.) In Pacific Trust, the court distinguished cases cited by the plaintiff in which the courts held that a lender could not assess a prepayment penalty when the lender accelerated the balance of the payment due as the provisions in those cases did not contain language specifying the penalty was due whether the prepayment was voluntary or involuntary and concluded that as the language in that case allowed imposition of the penalty whether prepayment was voluntary or involuntary "the lender could impose a prepayment charge after accelerating the obligation upon the buyer's default." (Pacific Trust Co. TTEE v. Fidelity Fed. Sav. & Loan Assn., supra, 184 Cal.App.3d 817, 824; see also Biancalana v. Fleming (1996) 45 Cal.App.4th 698, 703-704; Golden Forest Properties, Inc. v. Columbia Sav. & Loan Assn. (1988) 202 Cal.App.3d 193, 196-200.) The instant provision indicated the prepayment penalty was intended to apply when defendant accelerated the Note.
        In Lazzareschi Inv. Co. v. San Francisco Fed. Sav. & Loan Assn. (1971) 22 Cal.App.3d 303, 307, in rejecting a buyer's argument that a prepayment fee was excessive as it bore no reasonable relationship to any damage sustained by virtue of the prepayment, the court reasoned: "But the Freedman [v. The Rector (1951) 37 Cal.2d 16] case and all of those which have been based on it are concerned with breach of a contract in some manner. In the instant case, there has been no breach. The borrower had the option, clearly spelled out in the promissory note, of making one or more prepayments. He, by the action of the receiver, availed himself of the option. This is not a situation of liquidated damages. Although the word 'penalty' is used, and perhaps properly so in that a charge is made which is equivalent to unearned interest, there is no penalty in the sense of retribution for breach of an agreement, nor is there provision for liquidated damages because of ascertaining what the damages for such breach may be. Nor is the case one in which there is forfeiture for a default which, under appropriate circumstances, may be relieved under Civil Code section 3275, . . . Indeed, in the case before us there is the opposite of default, that is, a payment made before the promisor was obligated to make it."
        We disagree with plaintiffs' argument that the provision here should be construed as a late charge or forfeiture as it was triggered by their default. Under Gutzi, it is clear that if the provision had stated the penalty would be imposed if there was a prepayment, the provision would have been valid. We conclude the provision was not made invalid by conditioning a waiver upon a lack of default. Accordingly, we hold that as the penalty was triggered by the prepayment, it was a valid prepayment provision and not an invalid late charge or forfeiture.
        Defendant suggests this court should enter judgment in its favor as the trial court must have found the provision was not ambiguous. Plaintiffs suggest we apply the substantial evidence rule and accept their interpretation of the provision. We disagree with both positions. Based on the wording of the court's ruling, we conclude that it determined that the provision was a late charge as a matter of law and that the court made no findings on the issues of whether the provision was ambiguous or what it meant.
        "A contract is ambiguous when on its face it is capable of two different reasonable interpretations." (Pedersen v. Fiksdal (1960) 185 Cal.App.2d 30, 34.)
        The original prepayment clause in the note essentially stated that there would be a prepayment charge of six months' interest if the loan was paid off during the first five years after the date of the note. The note was for two years. When Robert called that provision to defendant's attention, an addendum was added stating:

        "PROVIDED ALL SCHEDULED PAYMENTS HAVE BEEN RECEIVED NOT MORE THAN 15 DAYS AFTER THEIR SCHEDULED DUE DATE, AND FURTHER PROVIDED THAT THERE HAVE BEEN NO OTHER DEFAULTS UNDER THE TERMS OF THIS NOTE OR ANY OTHER NOW EXISTING OR FUTURE OBLIGATION OF BORROWER TO TOPA, THEN NO PREPAYMENT CHARGE WILL BE ASSESSED IF THIS LOAN IS PAID IN FULL AFTER June 21, 1991."

        Defendant argues that provision should be interpreted to mean that it agreed to waive the prepayment charge after six months only in the event no defaults occurred before the time of the prepayment. Plaintiffs argue that the clause provided that no prepayment charge could be imposed after six months provided that they made all of the payments up to that date in a timely manner.
        An appellate court may make an independent interpretation of a written contract where there is no need for extrinsic evidence. (See Milazo v. Gulf Ins. Co. (1990) 224 Cal.App.3d 1528, 1534.) We conclude that under the plain language of the provision, defendant's interpretation is the only reasonable one. (See Moss Dev. Co. v. Geary (1974) 41 Cal.App.3d 1, 9; 1 Witkin, Summary of Cal. Law, supra, Contracts, § 681, p. 615.)
        On appeal, plaintiffs argue that principles of waiver and estoppel should bar defendant from assessing the prepayment penalty. "Estoppel in pais, also called estoppel by conduct, estoppel by misrepresentation and equitable estoppel, arises from declarations or conduct of the party estopped. 'Whenever a party has, by his own statement or conduct, intentionally and deliberately led another to believe a particular thing true and to act upon such belief, he is not, in any litigation arising out of such statement or conduct, permitted to contradict it.'" (11 Witkin, Summary of Cal. Law (9th ed. 1990) Equity, § 177, p. 858.) "It has been said that there must be (a) a representation or concealment of material facts (b) made with knowledge, actual or virtual, of the facts (c) to a party ignorant, actually and permissibly, of the truth (d) with the intention, actual or virtual, that the latter act upon it; and (e) the party must have been induced to act upon it." (Italics deleted.) (Id., at p. 859.) "There can be no estoppel where one of these elements is missing." (Ibid.)
        Plaintiffs argue these principles apply as they fully complied with the terms of the Note and all modifications thereto and there were no defaults. Defendant argues plaintiffs were in default because they did not make the payment due on February 1, 1992, on time. Plaintiffs argue the March 12 payment was for the February payment. Plaintiffs' position seems to be that because they were never advised they were in default and because they were led to believe compliance with the rescheduled payment plan would be acceptable, they were somehow misled. Even assuming all that to be true, plaintiffs knew when the payment was due. The payment was not made within the required 15 days. Estoppel is not applicable to this case. Moreover, there was no waiver of prepayment provision because defendant waived certain late charges as there was no indication of an intent to relinquish or abandon a known right by an act not consistent with any other reasonable explanation of the conduct. (See Central Bank v. Superior Court (1978) 81 Cal.App.3d 592, 600-601.)
        The record shows that defendant tried to work with plaintiffs on the loan. Besides waiving the late charge, defendant changed the due date of the payments and accepted reduced payments for March and April 1992 in order to assist plaintiffs with the sale of the Property. There are no triable issues relating to the application of the principles of waiver or estoppel. Accordingly, having determined as a matter of law that defendant was entitled to collect the prepayment penalty and that there are no factual issues relating to estoppel or waiver, we will order the court to enter judgment for defendant.
        We need not address the issues of whether the interest awarded was correct or whether the court abused its discretion by not awarding the full amount of attorney's fees requested. However, we admonish counsel on two matters. First, a statement of decision would have been helpful on both appeals. Second, counsel should refrain from the constant demands that sanctions be awarded. The parties had a legitimate legal dispute. A particularly egregious example is the request by plaintiffs in their reply brief on cross-appeal that sanctions be awarded against defendant for a frivolous appeal as the law was so set defendant should have known the provision was invalid. Not only was the request not made on appeal, it was made at a time when defendant would have no opportunity to respond and in a brief arguing that plaintiffs were entitled to $80,000 as attorney's fees rather than the mere $45,000 awarded as the matter was so complex and involved so many issues the requested fees were reasonable. Such a request is not only without merit, it is close to being frivolous.

DISPOSITION         The judgment is reversed, and the court is ordered to enter judgment in favor of defendant. Appellants to recover costs on appeal.


I concur:
        LILLIE, P.J.



JOHNSON, J.

        I respectfully dissent.
        I have some concern the contractual provision may be ambiguous on the question whether a prepayment charge could be assessed after June 21, 1991, as did the court hearing the earlier summary judgment motion. But that is not the basis of this dissent. Rather I accept the trial court's conclusion this provision does purport to impose a six-month interest charge for late payments or any other default including those which occur after that critical date. Like the trial court and unlike my colleagues, however, I also consider "the prepayment clause as written . . . was in fact a late charge and a penalty in the nature of" an unenforceable forfeiture under Garrett v. Coast and Southern Federal Savings and Loan Assn. (1973) 9 Cal.3d 731, and related cases. (Maj. opn. at p. 7.)
        At oral argument, counsel for Topa Thrift conceded a fee in the amount of six months' interest for being late with a monthly payment would constitute an unenforceable penalty. In this case, Topa imposed a prepayment penalty of over $100,000 as a result of the Ridgleys being a few weeks tardy in paying a monthly interest charge. Clearly, a penalty that onerous would exhibit "[t]he characteristic feature of a penalty . . . its lack of proportional relation to the damages which may actually flow from failure to perform . . . ." (Garrett v. Coast & Southern Fed. Sav. & Loan Assn., supra, 9 Cal.3d at p. 739.) In this case, the "failure to perform" is simply the failure to make one of the monthly payments on time. And it is the damages flowing from this late payment which must bear a "proportional relationship" to the $113,000 interest charge if that charge is to avoid classification as an unenforceable forfeiture. Topa's counsel, of course, declined to acknowledge this prepayment clause is the functional equivalent of a late fee of that size. In my view it is, and therefore, is unenforceable.
        For the convenience of the reader, I repeat the prepayment clause in its entirety although it appears in the majority opinion as well (maj. opn. at p. ____):

        "Provided all scheduled payments have been received not more than 15 days after their scheduled due date, and further provided that there have been no other defaults under the terms of this note or any other now existing or future obligation of borrower to Topa, then no prepayment charge will be assessed if this loan is paid in full after June 21, 1991."

        In its briefing, Topa argued this clause must be read as imposing an unconditional prepayment fee should the Ridgleys pay off the principal of the loan during the first six months and a conditional prepayment fee should they pay it off after the first six months. That is, the Ridgleys had to pay the six months' interest charge if they paid off the loan during the first six months whether they were timely or late in making their regular monthly payments during that period. But if they paid off the loan in the seventh or succeeding months they would only owe the interest charge if they had been late with one or more of their monthly payments anytime during the term of the loan (whether before or after the initial six-month period.) ² To reinforce this interpretation, Topa pointed out an integral part of the loan arrangements required the Ridgleys to place a portion of the loan proceeds in a special account maintained by Topa. This deposit equaled the first ten months of payments due under the loan and thus insured there could not be any late payments during the initial six month term of the loan.
        What this all meant, of course, is that after the initial six months Topa could not impose the prepayment penalty for the reason the Ridgleys were prepaying the loan before it matured and thus for the legitimate purpose of "compensat[ing] for the anticipated interest payments lost by prepayment." (Maj. opn. at p. 3.) Rather, after June 21, 1991, Topa could only assess this fee in the event the Ridgleys defaulted on other terms of the contract. As such, this clause falls squarely within the definition of a penalty or forfeiture which is invalid unless proportionate to the damages sustained. As the California Supreme Court explained in Garrett, "[a] penalty provision operates to compel performance of an act . . . and usually becomes effective only in the event of default . . . upon which a forfeiture is compelled without regard to the actual damages sustained by the party aggrieved by the breach." (Garrett v. Coast & Southern Fed. Sav. & Loan Assn., supra, 9 Cal.3d at p. 739.)
        In effect, by limiting its unconditional recovery of prepayment interest to the first six months, Topa was saying it would recover enough in interest payments during that period to compensate fully for lost future interest payments as well as the administrative costs of negotiating this loan and then replacing it with a new loan from another borrower for whatever term remained on this loan. But to ensure the Ridgleys would not be late on any of their interest payments (or default on any other terms of the contract), Topa held over their heads the threat of a $113,000 prepayment penalty which could be collected only "in the event of [such] default."
        Neither Topa nor the majority opinion explains the logical relationship between a borrower's late payment of one of the monthly interest charges and the rationale for allowing lenders to collect prepayment penalties. That is, prepayment penalties are permitted in order to compensate lenders for the loss of interest payments they otherwise would receive if the loan continued to maturity and also to compensate them for the administrative costs attendant to negotiating the original loan and extra costs of re-loaning the funds to a new borrower earlier than otherwise would have been required. (See, e.g., Drennan v. Security Pac. Nat. Bank (1981) 28 Cal.3d 764, 777-778; Pacific Trust Co. TTEE v. Fidelity Fed. Sav. & Loan Assn. (1986) 184 Cal.App.3d 817, 823-824; 4 Miller & Starr, Cal. Real Estate (2d ed. 1989) § 9:80, pp. 236-238, and cases cited therein.) Furthermore, the lender has need of this compensation no matter whether the loan terminates voluntarily or involuntarily. (Pacific Trust Co. TTEE v. Fidelity Fed. Sav. & Loan Assn., supra, 184 Cal.App.3d 817, 823-824.)
        But it is difficult to comprehend how Topa suffered a greater loss at the time the Ridgleys paid off this loan because they had been late with one payment (or even had it been two or three or more) than they would have had the Ridgleys been current with every payment during the period the loan remained in effect. To put it another way, the amount of Topa's lost future interest payments and extra administrative expenses is determined by when the Ridgleys paid off the loan and not by whether they were or were not late with some interest payments during the period the loan was in effect. Accordingly, it is more than apparent this prepayment penalty is being imposed as a penalty for the Ridgleys' default in being tardy with one or more monthly interest payments and not to compensate Topa for its lost future interest payments or extra administrative expenses attendant to re-lending this money. As such, the amount of this prepayment penalty must be measured against the standards applicable to penalty charges assessed for contractual defaults.
        "Late charges . . . serve a dual purpose: (1) they compensate the lender for its administrative expenses and the cost of money wrongfully withheld; and (2) they encourage the borrower to make timely future payments. Whether late charges represent a reasonable endeavor to estimate fair compensation depends upon the motivation and purpose in imposing such charges and their effect. If the sum extracted from the borrower is designed to exceed substantially the damages suffered by the lender, the provision for the additional sum, whatever its label, is an invalid attempt to impose a penalty inasmuch as its 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." (Garrett v Coast & Southern Fed. Sav. & Loan Assn., supra, 9 Cal.3d 731, 739-740.)
        As Topa's own counsel conceded, and is indisputable, the $113,000 in prepayment penalties Topa exacted "exceed[s] substantially the damages suffered by the lender" as a result of the Ridgleys' late payment of one or two monthly interest charges. (Garrett v. Coast & Southern Fed. Sav. & Loan Assn., supra, 9 Cal.3d 731, 739.) Indeed the very same loan documents provided for a late payment penalty which amounted to $1,515.79. Presumably, this figure was enough to compensate Topa for its lost interest and administrative expenses during the period the payment was delinquent and thus was a legitimate late payment charge. But Topa did not even attempt to argue, to say nothing of proving, it suffered nearly eighty times that late payment fee-$113,000-in lost interest income and expenses as a result of the Ridgleys' tardy payment of one and at most two monthly interest charges. Accordingly, this prepayment penalty, payable only in the event of default, is an invalid forfeiture.
        The vice of this sort of prepayment clause may be more apparent if we realize there is no legally significant difference between the clause in this loan and one inserted in a thirty year loan which applied throughout the term of that loan but was only activated if the borrower was late with a payment or committed some other minor default. There is no magic in the first six month period this loan document happened to include, during which the borrowers owed a prepayment charge for an early payment whether or not they defaulted in any way. Under the rationale of the majority opinion, the loan could have limited the imposition of a prepayment charge to late payment situations or other defaults throughout the term of the loan. Furthermore, there is no magic in the fact this was a two year loan not a thirty year one. What is significant is the fact the law presently prohibits lenders from charging a late payment fee greater than the damages they actually suffer from the delayed payment. But if the rationale of the majority opinion is upheld they will be free to create a new, much larger hammer to hold over the head of borrowers-the threat of a huge so-called "prepayment interest charge"-should they be late with any of their payments or default on any other provision of the loan. Unlike late payment fees, this conditional "prepayment interest charge" will not be subject to the limitation it bear some "relationship to the amount of the actual loss incurred by the lender" because of the delay in making the payment. Thus, lenders will be able to accomplish indirectly what the law prohibits them from doing directly-imposing an otherwise "invalid penalty" on borrowers for late payments and similar minor defaults.
        In another attempt to accomplish indirectly what it cannot do directly, Topa seeks to characterize this not as a prepayment penalty imposed for paying late but as a "waiver" of the prepayment penalty, otherwise owed, for paying on time. This, of course, is mere sophistry. Almost any sanction or penalty can be rephrased in the language of waiver. Imagine an outrageous and illegal late payment fee expressed in the following terms: "the interest rate is twenty percent, but if the borrowers make timely payments the interest rate shall be ten percent." Under such language, the lender could claim entitlement to a twenty percent interest rate which it "waives" to half that level for borrowers who pay loan installments on time. But in reality the lender would be imposing a penalty of a doubled interest rate for those who were tardy with their payments.
        The Supreme Court has spoken to these and like attempts to evade the prohibitions on penalties and forfeitures in loan arrangements. "The mere fact that an agreement may be construed, if in fact it can be, to vest in one party an option to perform in a manner which, if it were not so construed, would result in a penalty does not validate the agreement. To so hold would be to condone a result which, although directly prohibited by the Legislature, may nevertheless be indirectly accomplished through the imagination of inventive minds. . . . We have consistently ignored form and sought out the substance of arrangements which purport to legitimate penalties and forfeitures. [Citations.]" (Garrett v. Coast & Southern Fed. Savings & Loan Assn., supra, 9 Cal.3d 731, 737, italics added.)
        A few decisions help illustrate the principle that a penalty, however disguised, cannot be upheld as a valid measure to enforce prompt payment.         For example, in Baypoint Mortgage Corp. v. Crest Premium Real Estate Etc. Trust (1985) 168 Cal.App.3d 818 we held the penalty of foreclosure as a result of a mortgage payment made after the due date but before late charges accrued was an illegal penalty amounting to a forfeiture. "It is evident Crest Premium expects the threat of foreclosure actions will compel Baypoint to pay its future installments on or before the first of the month. This follows because any time Baypoint failed to do so, Crest Premium would be in a position to file a foreclosure action. And each time it would cost Baypoint some $15,000 in payments to trustees, etc. to avoid actual foreclosure. Thus, in essence, Crest Premium would be able to impose a $15,000 penalty for late payments even when those payments were only a day or two late. Since the installments Baypoint owes run about $12,000 a month, that late payment penalty would exceed 100 percent of the monthly payments themselves.
        "'The law looks with disfavor upon forfeitures, . . . .' (Talbot v. Gadia (1954) 123 Cal.App.2d 712, 719.) It is particularly reluctant to enforce forfeitures where the default is minor. . . .
        "In another line of cases, the California courts have disapproved the use of excessive financial penalties to coerce timely payment of loan installments. (See, e.g., Garrett v. Coast & Southern Fed. Sav. & Loan Assn. (1973) 9 Cal.3d 731; Bondanza v. Peninsula Hospital & Medical Center (1979) 23 Cal.3d 260.) They have ruled late payment fees cannot be set at a high level for this purpose. Such provisions have been held invalid by the California Supreme Court because they constitute 'a penalty, i.e., an attempt to coerce timely payment by a forfeiture not reasonably calculated to merely compensate the lender, but to penalize the borrower.' (Bondanza v. Peninsula Hospital & Medical Center, supra, 23 Cal.3d 260, 266, [italics added].) Indeed the courts have limited these fees to an amount necessary to compensate for the actual damages occasioned by the delay and to defray the administrative costs legitimately associated with delayed payment. (Garrett v. Coast & Southern Fed. Sav. & Loan Assn., supra, 9 Cal.3d 731, 741.)" (Baypoint Mortgage Corp. v. Crest Premium Real Estate Etc. Trust, supra, 168 Cal.App.3d at pp. 828-829.)
        Similarly, in Sybron Corp. v. Clark Hospital Supply Corp. (1978) 76 Cal.App.3d 896 the buyers were delinquent in their payments for the purchase of hospital beds. The parties entered into an agreement to pay the seller $72,000 in 12 equal monthly installments with interest on the balance at 10 percent. The agreement further provided that in the event of an uncured default for more than 10 days, the buyers agreed to a stipulated judgment against them for $100,000. The buyer's installment payments were late five times and the seller obtained a stipulated judgment for $100,000. The trial court denied the buyer's request to set aside the judgment. (76 Cal.App.3d at pp. 898-899.)
        The appellate court reversed. It found the $28,000 differential between the installment obligation of $72,000 and the stipulated judgment of $100,000 constituted an unenforceable penalty and forfeiture imposed on the buyer for late payment. "We think the penalty at bench bears no reasonable relationship to actual damages suffered by [the seller] as the result of delay but to the contrary appears grossly disproportionate in amount. . . . [T]he equitable powers of the court exist to insure that the ultimate obligation imposed on the debtor is not unreasonable in proportion to the original obligation and the seriousness of the default. . . . At bench, enforcement of the default provisions under the 1975 agreement would result in a $28,000 penalty for delay in payment of $30,000, a penalty which bears no rational relationship to the amount of actual damages suffered by [the seller]. Such an agreement is unenforceable. [Citations.]" (76 Cal.App.3d at p. 903, italics in original.)
        The court in Chambreau v. Coughlan (1968) 263 Cal.App.2d 712 similarly found a penalty to coerce prompt payment an unenforceable illegal penalty. In Chambreau, the parties stipulated to judgment for $8,025, but agreed to stay execution provided defendants paid the lesser sum of $5,500 in regular monthly installments. In the event of default, the larger judgment would become effective. The defendants paid the full $5,500 but had been late paying one installment. (263 Cal.App.2d at pp. 713-715.) The defendants moved in the trial court for an order for satisfaction of judgment. The trial court granted the motion and the plaintiff appealed. He claimed the order should be set aside because one payment had been late and therefore the larger stipulated judgment applied. The appellate court disagreed. "We are of the opinion that the terms of the judgment are such that if the [defendants] failed to make the installment payments thereunder at the times and in the amounts specified, they would suffer a loss in the nature of a forfeiture, and that they were entitled to be relieved therefrom upon making full compensation. . . ." (263 Cal.App.2d at p. 716.)
        The lesson is the same here. Topa claims it would have been entitled to require a prepayment interest fee for the full term of the loan. If the lender had done so, the Ridgleys would have had to pay that extra six months' interest if they paid off the loan anytime before it matured and even if they had never been late with a monthly payment or otherwise defaulted. Like the hypothetical lender who "waived" half of the ordinary interest for borrowers who paid on time Topa "waived" the prepayment interest charge for the Ridgleys so long as they paid on time. Both suffer from the same fatal defect. In reality, they are illegal penalties couched in the language of waiver.
        In a final attempt to justify this conditional prepayment charge, Topa and the majority opinion both imply this is not a true "penalty" because borrowers need not pay it unless they choose to pay off the loan before it matures. That is, even if late with a payment or payments during the course of the loan a borrower can "avoid" paying the onerous six month interest penalty by continuing to make regular interest payments for the entire term of the loan. In many situations, of course, this is impossible. For instance, if the borrowers sell the house or other property securing the loan, voluntarily or involuntarily, they lose the option of paying the loan to maturity and thus would suffer the conditional prepayment penalty if they were late with a monthly payment even once during the period of the loan. Indeed most long-term loans are paid off, for one reason or another, sometime before they reach maturity. Consequently, if lenders are free to insert in most or all loans the sort of conditional prepayment penalty the majority opinion sanctions in this case the law will be handing them a new and heavy hammer which, as a practical matter, indeed will fall on borrowers in virtually every situation where they are late with even a single monthly payment or commit any other default of similar magnitude.
        Furthermore, even the loss of the opportunity to pay off a loan early without incurring a large prepayment interest charge (in this case $113,000) represents a severe penalty or forfeiture far beyond the damages the lender suffers as a result of the tardy payment. Once borrowers are late with a single payment they experience a substantial financial loss. Before that late payment, they could have weighed the advantages of an early payoff against continuing to make their monthly loan payments until maturity without factoring in an extra six-month interest charge for that early payoff. Once they are late with a monthly payment, however, they must continue paying monthly interest to the lender unless or until it is worthwhile to incur that six-month interest fee to avoid future monthly payments. Either way the lender stands to receive its "penalty"-either in the form of the prepayment interest charge or additional monthly interest payments the borrower otherwise would not make. Nothing in the prior decisions of our Supreme Court suggests lenders can put borrowers to such an expensive "Hobson's choice" as a penalty for being late with a single monthly payment or for a similar minor default.
        For all these reasons, I would affirm the judgment below. ³

JOHNSON, J.


¹ 1.         Plaintiffs note that the prepayment provision here is not the same as the standard provision in Pacific Trust and other cases. However, the provisions in those cases were subject to the limitations set forth in Civil Code section 2954.9, which is not applicable in this case.
         ² . It is not relevant to the rationale of this dissent, but Topa's prepayment clause also purported to impose this same prepayment penalty for any "other defaults under the terms of this note or any other now existing or future obligation of borrower to Topa . . ." Assume the Ridgleys negotiated a second loan with Topa for a completely different purpose, a $1,500 consumer loan, for instance, and were late with a single monthly payment on this second loan. Under the terms of the prepayment clause on the first loan, Topa would have collected a six-month prepayment interest penalty of some $113,000 when the Ridgleys paid off this 2.3 million dollar loan, even if they were never late with any payment owed under that loan, but only on the $1,500 consumer loan.

This is not the scenario of the instant case, but it is an entirely feasible scenario under the interpretation Topa and the majority opinion place on this prepayment clause. At a minimum, it further emphasizes this provision is indeed an "attempt to impose a penalty" in order to "compel prompt payment though the threat of imposition of charges bearing little or no relationship to the amount of the actual loss incurred by the lender." (Garrett v. Coast & Southern Fed. Sav. and Loan Assn., supra, 9 Cal.3d 731, 740.)
         ³ . The Ridgleys cross-appealed, challenging the adequacy of the attorney fee award they received from the trial court. I would affirm that portion of the trial court's judgment as well, but see no purpose in explaining my reasons. Given the majority's disposition of the prepayment penalty issue, that cross-appeal is no longer relevant.


8 Daily Appellate Report