In New Jersey, liquidated damages, such as late fees, default interest rates, and prepayment premiums, are subject to the test of reasonableness, that is, whether the stipulated damage clause is reasonable under the totality of the circumstances. MetLife v. Washington Ave. Assocs., L.P., 159 N.J. 484, 493-95 (1999); Westmark Commercial Mortgage Fund IV v. Teenform Associates, L.P., 362 N.J.Super. 336, 341 (App.Div.2003). See also Norwest Bank Minnesota v. Blair Road Associates, L.P., 252 F.Supp.2d 86, 93-94 (D.N.J.2003) (evaluating default interest rate in a commercial contract using reasonableness standard). Within the analysis is the settled principle stated in Westmount Country Club v. Kameny, 82 N.J.Super. 200, 205 (App.Div.1964), that "[p]arties to a contract may not fix a penalty for its breach .... such a contract is unlawful."
Because stipulated damages "may constitute an oppressive penalty," "[h]istorically, courts have closely scrutinized contract provisions that provided for the payment of specific damages upon breach." MetLife, 159 N.J. at 493; citing Wasserman's Inc. v. Middletown, 137 N.J. 238, 248 (1994). An agreement, made in advance of breach, fixing the damages therefore, is not enforceable as a contract and does not affect the damages recoverable for the breach, unless (a) the amount so fixed is a reasonable forecast of just compensation for the harm that is caused by the breach, and (b) the harm that is caused by the breach is one that is incapable or very difficult of accurate estimation. Ibid.; citing Restatement of Contracts § 339 ( 1932).
"New Jersey adopted the Restatement method for evaluating stipulated damage clauses in Westmount Country Club, 82 N.J.Super. 200." Ibid. However, since then, "[c]ourts began to treat the two-pronged Westmount test as a continuum; the more uncertain the damages caused by a breach, the more latitude courts gave the parties on their estimate of damages." Id. at 494. "Reasonableness is now the standard for deciding the validity of stipulated damages clauses, and it is determined 'under the totality of the circumstances. Id. at 495; citing Wasserman's Inc., 137 N.J. at 249.
The Court acknowledged this more flexible approach in Metlife, a foreclosure case challenging an enhanced default rate, which increased the contract rate by 15%. Id. at 494; citing Stuchin v. Kasirer, 237 N.J.Super. 604 (App.Div.), certif. denied, 121 N.J. 660 (1990). "Despite reciting the strict two-pronged test of Westmount, [the Court] remanded the issue to the trial court to receive 'appropriate evidence of the reasonableness or unreasonableness of the 15% rate increase[.]'" Metlife, 159 N.J. at 494-95; citing Stuchin, 237 N.J.Super. at 614.
"The MetLife Court also considered the validity of a clause increasing the rate of interest upon default in payment. The Court found that default interest rates are a common tool utilized by lenders to offset a portion of the damages incurred as a result of delinquent loans. Id. at 501, 732 A. 2d 493. The Court held that default interest rates should be measured for reasonableness and if found to be unreasonable, struck down as a penalty. Ibid. In MetLife, the default interest rate was 12.55%, three percentage points higher than the contract rate. The Court determined that the three percent increase in the interest rate was a reasonable estimate of the lender's potential costs of administering a defaulted loan, as well as the potential difference in interest rates between the defaulted loan and a replacement loan the lender may be able to place. Ibid." Westmark, 362 N.J.Super. at 342.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
