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Late Fee For Rent in California Explained

By on June 2, 2019

What are late fees?

Late fees and similar liquidated damages provisions “serve an important function. They remove the uncertainty factor from determining damages from a breach of contract and reduce litigation.” UCAN v. AT&T Broadband of Southern Cal., 135 Cal. App. 4th 1023, 1038 (2006) (affirming the grant of summary judgment to defendant because liquidated damage clause in pre-printed contract was valid). Indeed, the California Legislature has specifically authorized late fees in lease agreements when (1) it would be “impracticable or extremely difficult” to determine actual damages; and (2) the parties agree upon the amount of the late fee. Civil Code § 1671(d). If those two conditions are met, then the agreed-upon late fee “shall be presumed to be the amount of damage sustained by a breach.” Id. The California Supreme Court, in Garrett v. Coast & Southern Fed. Sav. & Loan Assn., created a third requirement: the late fee “must represent the result of a reasonable endeavor by the parties to estimate a fair average compensation for any loss that may be sustained.” 9 Cal. 3d 731, 739 (1973); see also UCAN, 135 Cal. App. 4th at 1029 (noting that the “reasonable endeavor” test was a judicial creation). Garrett explains that this test focuses on “the motivation and purpose” for the late fee and the “effect” of the fee. Garrett, 9 Cal. 3d at 740-741. See also Rice v. Schmid, 18 Cal. 2d 382, 385 (1941) (“It is a question of fact in each instance whether the nature of the case is such that it would be impracticable or extremely difficult to fix the actual damage.”).

Liquidated Damages in Late Fees

Late fees and similar liquidated damages provisions “serve an important function. They remove the uncertainty factor from determining damages from a breach of contract and reduce litigation.” UCAN v. AT&T Broadband of Southern Cal., 135 Cal. App. 4th 1023, 1038 (2006) (affirming the grant of summary judgment to defendant because liquidated damage clause in pre-printed contract was valid). Indeed, the California Legislature has specifically authorized late fees in lease agreements when (1) it would be “impracticable or extremely difficult” to determine actual damages; and (2) the parties agree upon the amount of the late fee. Civil Code § 1671(d). If those two conditions are met, then the agreed-upon late fee “shall be presumed to be the amount of damage sustained by a breach.” Id. The California Supreme Court, in Garrett v. Coast & Southern Fed. Sav. & Loan Assn., created a third requirement: the late fee “must represent the result of a reasonable endeavor by the parties to estimate a fair average compensation for any loss that may be sustained.” 9 Cal. 3d 731, 739 (1973); see also UCAN, 135 Cal. App. 4th at 1029 (noting that the “reasonable endeavor” test was a judicial creation). Garrett explains that this test focuses on “the motivation and purpose” for the late fee and the “effect” of the fee. Garrett, 9 Cal. 3d at 740-741. See also Rice v. Schmid, 18 Cal. 2d 382, 385 (1941) (“It is a question of fact in each instance whether the nature of the case is such that it would be impracticable or extremely difficult to fix the actual damage.”).

When can landlords use liquidated damages for late fees?

Under Section 1671(d), late fees that charge a flat amount or a percentage of the total rent or outstanding balance are generally considered to be liquidated damages late fee provisions. According to California Civil Code section 1671(c)(2), the validity of such a liquidated damages provision in a residential property lease is determined under Civil Code section 1671(d). Under this section, these liquidated damages provisions are “void” unless the landlord proves both: (1) it is “impracticable or extremely difficult” to determine the actual damages caused by a late payment of rent; and (2) the landlord arrived at the late fee amount by making a “reasonable endeavor . . . to estimate a fair average compensation for any loss that may be sustained” by the late payment of rent. See Garrett v. Coast & S. Fed. Saving & Loan Assoc., 9 Cal. 3d 731, 738-39 (1973). If the landlord fails to may either of these showings, the late fees paid by tenants must be returned to them. However, these amounts may be reduced, or offset, by the amount of any actual costs the landlord can prove were suffered as a result of the tenant’s late payment of rent. The burden is on the landlord, as the proponent of the late fee, to prove that it made a reasonable endeavor to estimate its damages prior to setting the late fee. In re Cellphone Termination Fee Cases, 193 Cal. App. 4th 298, 322, 327 (2011).

What is a “reasonable” liquidated damage late fee?

Determining what is “reasonable” almost always requires the resolution of factual disputes. See, e.g., Poling v. Morgan, 829 F.2d 882, 887 (9th Cir. 1987) (in evaluating whether a property disposition is “commercially reasonable,” the “determination of what is reasonable is generally a question of fact”); Grisham v. Philip Morris U.S.A., Inc., 40 Cal. 4th 623, 637-638 (2007) (question of whether reliance was reasonable is generally a question of fact for the jury). The same is true for issues of motive and intent. See e.g. Fantasy, Inc. v. Fogerty, 984 F.2d 1524, 1531 (9th Cir. 1993) (observing that “questions of motive and intent are not generally susceptible to disposition on summary judgment”); NBA v. SDC Basketball Club, 815 F.2d 562, 567 (9th Cir. 1987) (where motive and intent play leading roles, summary judgment is rarely warranted). Other jurisdictions have also found that late fees of 5% (and in some cases more) are presumptively reasonable. See e.g., R.C.W. 19.150.150 (late fees up to 20% of the monthly rent “are reasonable”); Tenn. Code Ann. § 66-28-201 (late fees up to 10% of the rent past due are reasonable); N.C. Gen. Stat. § 42-46 (authorizing late fees up to 5% of the monthly rent); Chicago Mun. Code Ch. 5-12-140(h) (authorizing late fees of 5% for rent exceeding $500).

Two factors at the heart of any inquiry into whether a reasonable endeavor was made: “(1) the motivation and purpose in imposing the charges, and (2) their effect.” UCAN, 135 Cal. App. 4th at 1029. When assessing the effect, the “focus is not . . . on whether [the late fees] are disproportionate to the loss from breach, but on whether they were intended to exceed loss substantially—a result of which is to generate a profit.” Hitz, 38 Cal. App. 4th at 289. In other words, to be unlawful, the late fee must bear “no reasonable relationship to the range of actual damages that the parties could have anticipated would flow from a breach.” Ridgley v. Topa Thrift & Loan Assn., 17 Cal. 4th 970, 977 (1998).

Proper analysis for late fees under “reasonable endeavor” standard

To establish that a late fee was imposed with a lawful motivation and purpose, a landlord must show that it “actually engaged in some form of analysis to determine what losses it would sustain from the breach and that it made a genuine effort to estimate a fair average compensation for the losses to be sustained.” In re Cellphone, 193 Cal. App. 4th at 327-28. (“[A]s to Sprint’s motive and purpose, whatever information as to costs and revenues Sprint may have been ‘aware’ of, it cites to no evidence in the trial record that any of this information was part of the calculus in deciding to impose ETF’s [early termination fees], or in determining the amount of an ETF”); Hitz v. First Interstate Bank, 38 Cal. App. 4th 274, 290-91 (1995) (the required “reasonable endeavor” “cannot occur without some sort of analysis of the loss that is to be compensated,” and accepting the trial court’s finding that it was “incredible that, had the bank in fact intended to recover its actual anticipated damages by imposing [credit card late] fees, it would have adopted the fee without the benefit of a cost study or other appropriate analysis to determine its damages resulting from cardholders’ breach of contract.”) “If no effort was made to estimate the actual losses, then the resulting fee cannot approximate the losses.” Ruling & Decision at 5, Del Monte Props. & Invs., Inc. v. Dolan, No. CV170392 (Humboldt Cty. Super. Ct. App. Div. May 11, 2018).5 Accord, Hitz, 38 Cal. App. 4th at 291 (“such an estimate cannot occur without some sort of analysis of the loss” from the breach that is to be compensated.) Without this analysis, a landlord cannot demonstrate a lawful motivation or purpose in imposing a late fee.

Significantly, the validity of a late fee is determined by circumstances existing when the fee is inserted into the contract. Thus, the analysis of actual losses must be made before setting the amount of liquidated damages. Util. Consumers’ Action Network, Inc. v. AT&T Broadband of S. Cal., Inc., 135 Cal. App. 4th 1023, 1031 (2006); Ballard v. Equifax Check Servs., Inc., 158 F. Supp. 2d 1163, 1174 (E.D. Cal. 2001) (an analysis performed after setting the liquidated damages provision is “not relevant to the validity of the fees”; granting summary judgment for plaintiffs); Hitz, 38 Cal. App. 4th at 291-92; Hahn v. Massage Envy Franchising, LLC, No. 3:12-cv-00153-DMS-BGS, 2014 WL 5100220, at *12 (S.D. Cal. Sept. 25, 2014) (granting partial summary judgment to the plaintiffs because the defendant admitted that it “did not attempt to estimate actual damages” when setting the fee).

In re Cellphone, however, established that setting a liquidated damages provision based on what a company thinks is competitive in the marketplace is inconsistent with a lawful motivation under Garrett. In re Cellphone, 193 Cal. App. 4th at 320 (rejecting a late fee that was set, not on the basis “of any actual or estimated loss, but from a competitive standpoint.”) “[I]nstitutional intuition is not a substitute for analytical evaluation, and retrospective rationalization does not excuse the objective assessment required at the inception of the contract.” Id. at 327-28. In re Cellphone, 193 Cal. App. 4th at 324 (a company’s general sense that its damages caused by the breach match the late fee cannot satisfy the reasonable endeavor test.); Hitz, 38 Cal. App. 4th at 290 (“general knowledge” and “opinion” on costs “simply do not constitute the type of reasonable endeavor to estimate actual loss or damages that is required.”).

A landlord may try to introduce some kind of retrospective study that it performs in order to argue for the recoup of actual costs of the late payment of rent. But that justification, even if true, would come too late. Util. Consumers’ Action Network, 135 Cal. App. 4th at 1031; Ballard, 158 F. Supp. 2d at 1174. In re Cellphone explained the importance of conducting a cost analysis prior to setting a late fee: “[F]ocusing solely on hindsight justifications would render the reasonable endeavor requirement meaningless if no effort at foresight were required, and arbitrarily selected charges could be routinely imposed in consumer contracts, subject only to the ability of a company to muster a credible defense if challenged in litigation. If no attempt to make a reasonable assessment of potential loss is required at the outset, and to make the amount of the liquidated damages consonant with that assessment, one of the important functions that liquidated damages serve, removing the uncertainty factor from determining damages from a breach of contract and reducing litigation, would be lost. ” 193 Cal. App. 4th at 327; see also Irwin v. Mascot, 96 F. Supp. 2d 968, 977 (N.D. Cal. 1999) (citing Hitz, 38 Cal. App. 4th at 288) (“The validity of the liquidated damages clause is determined by the circumstances existing when the fee provisions are inserted into an agreement, and not by subsequent events”). Accordingly, “[t]he parties’ reasonable endeavor to estimate the loss must precede the setting of fees.” Irwin, 96 F. Supp. 2d at 977 (citing Hitz, 38 Cal. App. 4th at 291-92). Thus, even if a landlord could theoretically prove after imposing the late fee that the fee does reflect its actual costs, that would not rescue the it from being declared void. As such, a landlord cannot meet its burden of demonstrating that the late fee passes the reasonable endeavor test.

Landlord offset for damages relating to late fees

Also noteworthy, a landlord may reduce, or “offset,” the amount it is to return to the tenants by the amount of actual damages it succeeds in proving were proximately caused by tenants’ late payment of rent, Garrett, 9 Cal. 3d at 740-41, so long as the damages are in accordance with the language of the lease and applicable law. Beasley, 235 Cal. App. 3d at 1402-06. The landlord also bears the burden of proof on its offset defense and other affirmative defenses. Conrad v. Ball Corp., 24 Cal. App. 4th 439, 444 (1994); Garrett, 9 Cal. 3d at 738, 741.

A landlord’s offset under Garrett must be limited to the damages purportedly liquidated by the General lease agreement. See Garrett, 9 Cal. 3d at 741 (a void liquidated damages provision is replaced by “the actual damages” resulting from the relevant breach). If the tenant makes the required late payment within the three days, “the right to possession remains in effect as if there had been no default.” Briggs v. Elec. Memories & Magnetics Corp., 53 Cal. App. 3d 900, 905 (1975); Code of Civ. Proc. § 1161.5.7. 7. In effect, this three-day period “gives tenants additional time to pay their rent without endangering their tenancy,” and is therefore an additional “grace period provided by California law.” Gersten Cos. v. Deloney, 212 Cal. App. 3d 1119, 1129 (1989). If, after three days, the tenant is still in the unit but has not paid the rent owed, then the landlord has the right to file an unlawful detainer action to evict the tenant for “nonpayment of rent.” Kruger v. Reyes, 232 Cal. App. 4th Supp. 10, 16 (Cal. App. Div. Super. Ct. 2014); Code of Civ. Proc. § 1161(2). While the landlord can choose to waive the breach and allow the tenant to continue under the lease, at the end of the three-day period, the tenant’s power to unilaterally cure the default is extinguished. See Code of Civ. Proc. § 1161.5. At that point, default is complete: the late payment of rent has become, legally speaking, “nonpayment of rent.” Kruger, 232 Cal. App. 4th Supp. at 16.

A slightly different timeline applies if a tenant abandons the unit after failing to pay rent or receiving a 3-day notice. Under California law, the lease is deemed terminated by the tenant’s departure. Civ. Code § 1951.2(a) (“[I]f a lessee of real property breaches the lease and abandons the property before the end of the term … the lease terminates”). A landlord can recover its actual damages after the tenant’s departure under Civil Code section 1951.2(a). Section 1951.2. specifies that the landlord may recover unpaid rent that has already accrued at the time of abandonment as well as rent that would have come due after the date of termination, limited by the amount of future rent damages the tenant proves the landlord could have avoided.

Because the landlord failed to engage in a reasonable endeavor to determine its losses from late payment of rent prior to setting a flat rate fee, the entire flat rate fee is void under Section 1671(d). In re Cellphone, 193 Cal. App. 4th at 327. The landlord’s violation of Section 1671(d) makes it liable under the UCL because the landlord’s late fee is an unlawful business act or practice. Hauk v. JP Morgan Chase Bank U.S., 552 F.3d 1114, 1122 (9th Cir. 2009). By creating an unlawful flat rate fee, landlords controlled its implementation, or collected and benefitted from late fees collected from the flat rate fee. If a late fee provision is found void under Section 1671(d), the late fees paid by tenants must be returned to them. Beasley v. Wells Fargo Bank, 235 Cal. App. 3d 1383, 1398-1401 (1991); Cal. Bus. & Prof. Code § 17203.

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