Graylee v. Castro (2020): Liquidated Damages in Stipulated Judgment Unenforceable Unless They Bear a Reasonable Relationship to Anticipated Damages Flowing from Breach

california state seal

“Section 1671, subdivision (b), provides that a liquidated damages clause ‘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’. Under this subdivision, a liquidated damages clause becomes an unenforceable penalty ‘if it bears no reasonable relationship to the range of actual damages that the parties could have anticipated would flow from a breach’. The amount set as liquidated damages ‘must represent the result of a reasonable endeavor by the parties to estimate a fair average compensation for any loss that may be sustained’. Absent a relationship between the liquidated damages and the damages the parties anticipated would result from a breach, a liquidated damages clause will be construed as an unenforceable penalty’. In the context of a stipulated judgment, the amount of the judgment must reasonably relate to the damages likely to arise from the breach of the stipulation, not the alleged breach of the underlying contract, because it is the breach of the stipulation that allows the plaintiff to enter judgment against the defendant. Thus, we analyze the damages flowing from the breach of the stipulation itself, not any damages that may have arisen from the tenants’ alleged breach of the underlying lease agreement.”

In Graylee v. Castro, a landlord served a three-day notice to pay rent or quit, contending his tenants owed $27,170 in unpaid rent for a house they leased, and filed an unlawful detainer action when they failed to cure the notice. The tenants answered and disputed the amount claimed in the notice. The parties settled prior to trial, pursuant to Section 664.6 of the Code of Civil Procedure, which allows parties to pending litigation to enter a settlement contract that calls for entry of a stipulated judgment (sometimes, as in this case, only in the event of breach).

The tenants were required to vacate the house by 3:00pm on October 31, 2018. If they did, all disputed rent would be waived, but if they failed to timely vacate, the landlord could enter judgment for $28,970, which included the unpaid rent/damages, attorneys’ fees and costs.

On the move-out day, the tenants were running a bit behind, dropped off the key at 1:15pm, but asked the property manager for a bit more time to vacate. The property manager allegedly drove by and saw the tenants still moving out of the house at 3:15pm. When the landlord moved to enforce the stipulation, the tenants disputed that they failed to timely vacate (stating they had vacated the house but were merely moving boxes into the moving truck after 3:00pm). Nonetheless, the trial court entered judgment in the entire amount.

The tenants appealed, contending the judgment amount constituted unenforceable liquidated damages. The Court of Appeal agreed and reversed. First, it found that the settlement agreement only for fixed damages of $28,970, and only awarded them in the event of breach, therefore the liquidated damages analysis applied.

The Court noted that liquidated damages provisions are unenforceable when they bear no relationship to the range of damages that the parties could have anticipated would flow from the breach. Instead, they must represent the result of a reasonable endeavor by the parties to estimate a fair average compensation for the loss resulting from breach. But without such a relationship between the liquidated damages and anticipated actual damages, these clauses are unenforceable.

Analyzing recent decisions, the Court considered other settlement agreements featuring compromises on an alleged debt. The crucial distinction between the cases where the sum was enforceable and those where it was not was whether the settlement was a compromise of a disputed claim or one that the parties did not dispute. If the claim was not disputed, then a judgment for the entire amount was justified an enforceable, notwithstanding a discount for, e.g., timely payment of the compromised sums. Because the $28,970 bore no relationship to the damages resulting from failure to vacate by 3:00pm exactly, it was an unenforceable liquidated damages provision.