When Assessing Whether Stipulated Judgment Amount is “Reasonable”

This case started with a breach of contract lawsuit filed by Vitatech against various defendants, seeking more than $166,000 in damages. On the eve of trial, the parties settled based upon defendants’ agreement to make a one-time payment of $75,000 by a designated date. As part of the settlement, and to “secure” defendants’ payment promise, defendants stipulated to entry of judgment against them “in the full prayer of the Complaint” – which included prejudgment interest, attorney’s fees and costs in addition to compensatory damages – and 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. When defendants failed to pay, Vitatech filed the stipulation and the trial court entered judgment against defendants for more than $300,000, which included compensatory damages, prejudgment interests, attorney’s fees and costs.

Defendants moved to vacate, arguing that it was an unenforceable penalty under Civil Code § 1671(b). The trial court denied defendants’ motion, finding that the higher amount was not a penalty or liquidated damages, and found that the reduced amount Vitatech had agreed to accept was merely a discount of the underlying contract debt if defendants paid as agreed.

On appeal to the Fourth District Court of Appeal, the court reversed and remanded to the trial court with instructions to grant defendants’ motion to vacate and to enter a new judgment for the $75,000 settlement amount, plus trial court costs.[1] In reaching its decision, the appellate court took a very different view from the trial court as to the backdrop against which the “reasonableness” of a liquidated damages provision should be evaluated. The trial court evaluated the liquidated damages provision in relation to (a) the relief Vitatech had sought in its complaint based upon the underlying commercial contract, and (b) the relief available under that contract for its breach. Taking a different approach, the Court of Appeal evaluated the liquidated damages provision in relation to the stated settlement amount, and held that the liquidated damages must bear a reasonable relationship to the range of damages that would result from defendants’ failure to pay the agreed upon settlement amount. Under well-established precedent, including the Fourth District’s earlier decision in Greentree Financial Group, Inc. v. Execute Sports, Inc., 163 Cal. App. 4th 495 (2008),[2] the court held that the stipulated judgment for more than four times the amount Vitatech agreed to accept in settlement bore no reasonable relationship to the range of damages the parties could have anticipated would result from defendants’ failure to timely pay the settlement amount and was thus an unenforceable penalty under Civil Code § 1671. The court reasoned that the stipulation for entry of judgment was not merely a permissible discount provision because the stipulation represented a compromise of disputed claims in which liability was contested. 16 Cal. App. 5th at 801. Contrary to Vitatech’s argument, the stipulation for entry of judgment was not merely a permissible discount provision because, while the defendants stipulated to entry of judgment if they did not timely pay, they did not admit liability on the underlying claim, nor did they concede the amount of damages caused by their alleged breach of the underlying contract.

Because the liquidated damages provision in the stipulated judgment was more than four times the amount Vitatech had agreed to accept in full settlement of its claims, the appellate court held that it was an unenforceable penalty because that disparity bore no reasonable relationship to the range of damages the parties could have anticipated would result from defendants’ failure to pay the agreed upon settlement amount. The court reached this conclusion as a matter of law on undisputed facts and relied upon the California Supreme Court’s decision in Ridgley v. Topa Thrift & Loan Assn., 17 Cal. 4th 970, 976-977 (1998) 16 Cal. App 5th at 806 (a loan provision permitting a borrower to prepay its loan without penalty, only if he was not otherwise in default, was held to constitute an invalid penalty for otherwise not making timely payments and was not justifiable as a lawful prepayment clause).

The appellate court reversed and remanded with directions for the trial court to grant the motion and to enter a new judgment for $75,000 based upon the parties’ stipulation for entry of judgment.

Note Further: An interesting aspect of this case is whether defendants properly sought to vacate the judgment under Code of Civil Procedure § 473(d), which allows for the vacation of void judgments. A judgment can be void when the court lacks fundamental authority over the subject matter, question presented or party, which does not seem to be the case here. However, the Court of Appeal found another example of a void judgment in this case: “void as against public policy.” Having found that the judgment was predicated upon a settlement stipulated that contained an unreasonable liquidated damages provision, the court held that the resulting judgment was avoid as against public policy.

Comment: What might have saved the stipulated judgment at issue in this case? The Court of Appeal analyzed other cases in which a stipulated judgment had been found to be valid, and suggested that the stipulated judgment here could have survived if the appellants had admitted their liability under the underlying contract or for the damages Vitatech was seeking in its complaint. Apparently, at least in the eyes of the Court of Appeal, there was a difference between the defendants’ agreement to stipulate to the “full prayer of the Complaint” and an “admission” of liability for those damages.

This decision illustrates the dangers and difficulties of trying to put “teeth” into a settlement by including provisions that increase the amount the settling defendant must pay if it fails to perform as promised. It also illustrates the need for careful drafting. For example, the settlement amount could have been stated as the full contract amount ($166,000), with an agreed upon discount at $75,000 if paid in full by the agreed upon deadline. It also could have been written to condition the release and dismissal upon payment of the settlement amount, especially since it was a single payment that was to be paid not that far in the near future. Finally, the stipulation for entry of judgment could have expressly included provision for the settling plaintiff to have the right to seek recovery of attorney’s fees and pre-judgment interest dating back to the filing of the lawsuit if defendants defaulted in the payment due under the settlement agreement.