DOBSON BAY CLUB II DD, LLC, A DELAWARE LIMITED LIABILITY COMPANY; DOBSON BAY CLUB III KD, LLC, A DELAWARE LIMITED LIABILITY COMPANY; DOBSON BAY CLUB IV KG, LLC, A DELAWARE LIMITED LIABILITY COMPANY; AND DARBY AZ PORTFOLIO, LLC, A DELAWARE LIMITED LIABILITY COMPANY, Plaintiffs/Appellants,
LA SONRISA DE SIENA, LLC, AN ARIZONA LIMITED LIABILITY COMPANY, Defendant/Appellee.
from the Superior Court in Maricopa County The Honorable John
Christian Rea, Judge No. CV2013-000989
of the Court of Appeals, Division One 239 Ariz. 132, 366 P.3d
1022 (App. 2016)
AND REMANDED VACATED
J. Pollock (argued), Jared L. Sutton, Lewis Roca Rothgerber
Christie LLP, Phoenix, Attorneys for Dobson Bay Club II DD,
LLC, et al.
Michael A. Schern, Mark A. Hanson, Schern Richardson Finter
Decker PLC, Mesa; and Stephen C. Biggs (argued), Smith LC,
Phoenix, Attorneys for La Sonrisa de Siena, LLC
Jeffrey Craven, The Craven Firm PLLC, Phoenix, Attorneys for
Amicus Curiae Arizona Private Lender Association
JUSTICE TIMMER authored the opinion of the Court, in which
CHIEF JUSTICE BALES, VICE CHIEF JUSTICE PELANDER, and JUSTICE
BRUTINEL joined. JUSTICE BOLICK dissented.
A liquidated damages contract provision is enforceable if the
pre-determined amount for damages seeks to compensate the
nonbreaching party rather than penalize the breaching party.
We here hold that a nearly $1.4 million late fee assessed on
a final loan balloon payment constitutes an unenforceable
In 2006, Canadian Imperial Bank of Commerce loaned Dobson Bay
Club II DD, LLC and related entities ("Dobson Bay")
$28.6 million for Dobson Bay's purchase of four
commercial properties. The loan was secured by a deed of
trust encumbering those properties. Under the terms of a
promissory note, Dobson Bay was to tender interest-only
payments to Canadian Imperial Bank until the loan matured in
September 2009, when the entire principal would become
due-the "balloon" payment. In 2009, the parties
extended the loan maturity date to September 2012.
Dobson Bay bore significant consequences for any delay in
payment. In addition to continuing to pay regular interest,
Dobson Bay was required to pay default interest and
collection costs, including reasonable attorney fees, and a
5% late fee assessed on the payment amount. If Canadian
Imperial Bank foreclosed the deed of trust, Dobson Bay was
also obligated to pay costs, trustee's fees, and
reasonable attorney fees.
As the 2012 loan maturity date approached, the parties
negotiated to extend that date but could not reach an
agreement. The maturity date passed, and Dobson Bay failed to
make the balloon payment.
La Sonrisa de Siena, LLC ("La Sonrisa") bought the
note and deed of trust from Canadian Imperial Bank and
promptly noticed a trustee's sale of the secured
properties. It contended that Dobson Bay owed more than $30
million, including a nearly $1.4 million late fee. Dobson Bay
disputed it owed various sums, including the late fee.
Litigation ensued. Dobson Bay secured new financing and paid
the outstanding principal and undisputed interest in March
2013. (Dobson Bay simultaneously deposited the disputed
amounts with the superior court pending the litigation.) The
parties filed cross-motions for partial summary judgment on
whether the late fee provision in the note was an enforceable
liquidated damages provision or, instead, an unenforceable
The superior court granted partial summary judgment for La
Sonrisa, ruling that the late fee was enforceable as
liquidated damages. The court of appeals reversed, holding
"as a matter of law, that absent unusual circumstances
the imposition of a flat 5% late-fee on a balloon payment for
a conventional, fixed-interest rate loan is not enforceable
as liquidated damages." Dobson Bay Club II DD, LLC
v. La Sonrisa de Siena, LLC, 239 Ariz. 132, 140 ¶
22, 366 P.3d 1022, 1030 (App. 2016).
We granted review because the enforceability of late fee
provisions in commercial loan agreements presents a legal
issue of statewide importance. We have jurisdiction pursuant
to article 6, section 5(3) of the Arizona Constitution and
A.R.S. § 12-120.24.
Enforceability of liquidated damages provisions
Parties to a contract can agree in advance to the amount of
damages for any breach. See Miller Cattle Co. v.
Mattice, 38 Ariz. 180, 190, 298 P. 640, 643 (1931). Such
"liquidated damages" provisions serve valuable
purposes. They provide certainty when actual damages would be
difficult to calculate, and they alleviate the need for
potentially expensive litigation. Cf. Mech. Air Eng'g
Co. v. Totem Constr. Co., 166 Ariz. 191, 193, 801 P.2d
426, 428 (App. 1989) (noting that a liquidated damages
provision "promotes enterprise by increasing certainty
and by decreasing risk-exposure, proof problems, and
litigation costs); Restatement (Second) of Contracts
("Restatement Second") § 356 cmt. a. (Am. Law
Inst. 1981) ("The enforcement of such provisions . . .
saves the time of courts, juries, parties and witnesses and
reduces the expense of litigation.").
Parties, however, do not have free rein in setting liquidated
damages. Because "[t]he central objective behind the
system of contract remedies is compensatory, not punitive,
" parties cannot provide a penalty for a breach.
Restatement Second § 356 cmt. a; see also id.
("Punishment of a promisor for having broken his promise
has no justification on either economic or other grounds and
a term providing such a penalty is unenforceable on grounds
of public policy."). "A [contract] term fixing
unreasonably large liquidated damages is unenforceable on
grounds of public policy as a penalty." Id.
§ 356(1). The contract remains valid, however, and the
non-breaching party can still recover actual damages. See
Gary Outdoor Advert. Co. v. Sun Lodge, Inc., 133 Ariz.
240, 243, 650 P.2d 1222, 1225 (1982); Miller Cattle,
38 Ariz. at 190, 298 P. at 643.
Arizona courts have used different methods to decide whether
stipulated damages provisions are enforceable as liquidated
damages or void as penalties. This Court has considered
whether the stipulated amounts were reasonably related to
actual damages. See Marshall v. Patzman, 81 Ariz.
367, 370, 306 P.2d 287, 289 (1957); Tennent v.
Leary, 81 Ariz. 243, 249, 304 P.2d 384, 388 (1956);
Weatherford v. Adams, 31 Ariz. 187, 197, 251 P. 453,
456 (1926); Armstrong v. Irwin, 26 Ariz. 1, 9, 221
P. 222, 225 (1923). We have also examined liquidated damages
provisions prospectively, considering whether they were
reasonable at the time the contracts were created. See
Gary Outdoor Advert. Co., 133 Ariz. at 242-43, 650 P.2d
at 1224-25; Miller Cattle, 38 Ariz. at 190, 298 P.
Our court of appeals has generally applied a two-part test
developed under the Restatement (First) of Contracts
("Restatement First") (Am. Law Inst. 1928) §
339. Under that test, which our dissenting colleague
implicitly relies on, see infra ¶ 50, a
stipulated damages provision is an unenforceable penalty
unless "(1) the amount fixed is a reasonable forecast of
just compensation for harm that is caused by the breach, and
(2) the harm caused is 'incapable or very difficult of
accurate estimation.'" Dobson Bay Club, 239
Ariz. at 136 ¶ 9, 366 P.3d at 1026 (citing Restatement
First § 339); see also Pima Sav. & Loan
Ass'n v. Rampello, 168 Ariz. 297, 300, 812 P.2d
1115, 1118 (App. 1991); Mech. Air Eng'g Co., 166
Ariz. at 193, 801 P.2d at 428; Larson-Hegstrom &
Assocs., Inc. v. Jeffries, 145 Ariz. 329, 333, 701 P.2d
587, 591 (App. 1985).
In this case, the court of appeals applied Restatement Second
§ 356(1), which reframed the Restatement First test in
1981 to harmonize with Uniform Commercial Code
("UCC") § 2-718(1). See Dobson Bay
Club, 239 Ariz. at 136 ¶ 9 n.2, 366 P.3d at 1026
n.2; Restatement Second § 356 reporter's note.
Section 356(1) provides that a liquidated damages provision
is enforceable, "but only at an amount that is
reasonable in the light of the anticipated or actual loss
caused by the breach and the difficulties of proof of
loss." This test requires courts to consider (1) the
anticipated or actual loss caused by the breach, and (2) the
difficulty of proof of loss. Whether a fixed amount is a
penalty turns on the relative strengths of these factors. As
explained by comment b to § 356:
If the difficulty of proof of loss is great, considerable
latitude is allowed in the approximation of anticipated or
actual harm. If, on the other hand, the difficulty of proof
of loss is slight, less latitude is allowed in that
approximation. If, to take an extreme case, it is clear that
no loss at all has occurred, a provision fixing a substantial
sum as damages is unenforceable.
La Sonrisa urges us to disavow the Restatement Second §
356(1) test to the extent it "retrospectively"
considers actual damages. It contends that this approach
undermines the contracting parties' freedom to allocate
risk and defeats the purpose of a liquidated damages
provision by requiring the non-breaching party to establish
actual damages. Not so.
Section 356(1) provides two methods for deciding whether the
parties' damages forecast was reasonable. The amount is
reasonable if it approximates either the loss anticipated at
the time of contract creation (despite any actual loss) or
the loss that actually resulted (despite what the parties
might have anticipated in other circumstances). See
Restatement Second § 356 cmt. b. The non-breaching party
is not required to prove actual damages to enforce a
liquidated damages provision, and a court will respect the
parties' agreement if it is "reasonable" in
relation to anticipated or actual loss. But if the difficulty
of proof of loss is slight and either no loss occurs or the
stipulated sum is grossly disproportionate to the loss, the
parties' stipulation would be unreasonable and therefore
unenforceable as a penalty. See id. This approach is
consistent with this Court's opinions. See
Marshall, 81 Ariz. at 370, 306 P.2d at 289 (holding that
stipulated damages were "unconscionable under the
circumstances" and unenforceable because the
non-breaching party suffered no loss); Weatherford,
31 Ariz. at 197, 251 P. at 456 ("Where the amount
retained is grossly disproportionate to the actual damages .
. . and, especially, when there is available a simple method
for ascertaining the exact damages, [a stipulated damages
provision] will be considered as a penalty.").
We adopt the Restatement Second § 356(1) to test the
enforceability of a stipulated damages provision. First,
§ 356(1) aligns with UCC § 2-718(1), which Arizona
has adopted. See A.R.S. § 47-2718(A). Thus,
courts can apply the same test to both UCC-governed and
non-UCC-governed contracts. Second, the test best
accommodates the goal of compensating the non-breaching party
for a loss rather than penalizing the breaching party. Under
the Restatement Second test, courts have ...