Lisa LeFavor, Respondent, vs. James C. Stuebner, Appellant.

This opinion will be unpublished and

may not be cited except as provided by

Minn. Stat. § 480 A. 08, subd. 3 (2002).

STATE OF MINNESOTA

IN COURT OF APPEALS

A04-509

Lisa LeFavor,

Respondent,

vs.

James C. Stuebner,

Appellant.

Filed October 12, 2004

Reversed

Lansing, Judge

Hennepin County District Court

File No. CT 02-21540

James A. Bumgardner, Terpstra, Black & Moore, Ltd., 812 Main Street, Suite 102, Elk River, MN 55330 (for respondent)

Jon S. Swierzewski, Chris M. Heffelbower, Larkin Hoffman Daley & Lindgren Ltd., 1500 Wells Fargo Plaza, 7900 Xerxes Avenue South, Minneapolis, MN 55431-1194 (for appellant)

            Considered and decided by Lansing, Presiding Judge; Harten, Judge; and Shumaker, Judge.

U N P U B L I S H E D   O P I N I O N

LANSING, Judge

            On stipulated facts the district court concluded that James Stuebner defaulted on the timely payment of quarterly interest on a $50,000 promissory note and that he was therefore obligated by the note's terms to pay an additional $50,000 because of the default.  In this appeal Stuebner argues that the additional $50,000 is an unenforceable penalty that cannot be construed as liquidated damages.  Because the additional $50,000 is predicated on readily ascertainable damages and is greatly disproportionate to any reasonable assessment of compensatory damages, we agree that it represents an impermissible penalty and we reverse.

Lisa LeFavor, the holder of a $50,000 promissory note, sued James Stuebner, the promissor, for default in failing to pay quarterly interest payments due under the terms of the note.  LeFavor obtained the note in an assignment from Hamelwood Construction, Inc. in October of 1997.  Stuebner executed the note payable to Hamelwood in March 1997 to settle litigation between Hamelwood and Stuebner over a previously executed promissory note.

            LeFavor and Stuebner stipulated to the relevant facts and submitted the stipulation to the district court for determination.  The stipulated facts included a statement that Stuebner agreed to make quarterly interest payments of eight percent on a principal sum of $50,000, with the entire balance due at the end of seven years.  The default provision, contained in the note and referenced in the stipulated facts, states that if Stuebner "defaults in the payment terms of this note, then, and in such instance, upon written notice provided by the payee to [Stuebner], [he] shall be obligated to pay, in addition to the amounts provided herein, the additional sum of Fifty Thousand Dollars ($50,000.00), as a penalty."  (Emphasis added.) 

Stuebner made nine interest payments on the note, two of which were late.  Stuebner's bookkeeper drafted and mailed an interest payment to LeFavor on March 31, 2000.  LeFavor did not receive the payment.  In May, LeFavor provided written notice of the default and also informed Stuebner that because of the default, Stuebner now owed an additional $50,000, and thus the total amount of the note had increased to $100,000.  Stuebner rejected LeFavor's claim that the additional $50,000 amount had been triggered by the untimely March payment and refused to pay the additional interest computed on $100,000.  In response, LeFavor brought this action.

The district court concluded that Stuebner defaulted by failing to pay timely the March 2000 quarterly interest payment and that "[t]he provision in the [n]ote for the sum of $50,000 to be paid in the event of default is reasonable given the circumstance at the time the [n]ote was made."  Stuebner appeals, contending that the additional $50,000 is not reasonable and represents an impermissible penalty.

D E C I S I O N

Contracting parties, under certain conditions, may stipulate or liquidate in advance the damages to be assessed in the event of a breach.  Frank v. Jansen, 303 Minn. 86, 91, 226 N.W.2d 739, 743 (1975).  Minnesota courts, consistent with courts in other states, recognize that a liquidated-damages provision is "a convenient substitute" for a "reasonable forecast of general damages."  Id. at 91-92, 226 N.W.2d at 743 (quoting Zirinsky v. Sheehan, 413 F.2d 481, 485 (8th Cir. 1969)).  Properly used, liquidated-damages provisions allow for prompt settlement of issues that otherwise may present difficulty, uncertainty, delay, and the expense of litigation.  Meuwissen v. H.E. Westerman Lumber Co., 218 Minn. 477, 484, 16 N.W.2d 546, 550 (1944).  To be valid, however, the liquidated sum must be "fair compensation for an injury caused by a breach of contract and not a penalty for nonperformance."  Gorco Constr. Co. v. Stein, 256 Minn. 476, 481, 99 N.W.2d 69, 74 (1959).

To determine if an amount is a valid liquidated damages provision, Minnesota courts consider whether (1) the amount represents an impermissible penalty, (2) the harm caused by the breach is susceptible or not susceptible to accurate estimation, and (3) the designated amount is greatly disproportionate to the damages caused by the breach.  See id. at 481-82, 99 N.W.2d at 74-75 (discussing factors for determining validity of provision).

In considering whether the default provision in Stuebner's promissory note is a penalty, we observe at the outset that the note itself uses the term "penalty" to describe the requirement that Stuebner pay a sum of $50,000 in the event of his default.  Caselaw, however, provides that the designation of a sum as "liquidated damages" or a "penalty" is not controlling.  See id. at 481-82, 99 N.W.2d at 74 ("In determining the issue neither the intention of the parties nor their expression of intention is the governing factor.").  It may be of some significance that the cases rejecting the designation as a controlling factor involve contractual provisions designating amounts as "liquidated damages" rather than a "penalty."  See, e.g., id.; Costello v. Johnson, 265 Minn. 204, 210, 121 N.W.2d 70, 75 (1963) (noting that the intention of the parties is not a controlling factor); Meuwissen, 218 Minn. at 484, 16 N.W.2d at 550.  Nonetheless, we accept that the designation is not binding.  Instead we consider whether the provision operates as a penalty by punishing nonperformance or operates as liquidated damages by forecasting compensatory damages.  See Gorco, 256 Minn. at 482, 99 N.W.2d at 74 (observing that a provision with a punitive impact is not enforceable).  In other words, the purpose of a penalty is to secure performance; the purpose of liquidating damages is to ascertain the amount of harm caused by failure to perform.  McGuckin v. Harvey, 177 Minn. 208, 209, 225 N.W. 19, 19 (1929).

The second consideration, whether the harm resulting from a breach is reasonably susceptible of estimation, must start with the fact that the "contract" at issue is a promissory note for a specific sum.  Stuebner argues that actual damages necessarily consist only of the interest accrued from when he failed to make the last payment to LeFavor until his alleged attempt to remedy that default.  We recognize that the damages arguably could be more extensive than the product of a simple-interest computation.  For instance, Hamelwood may have determined that it needed to reserve an amount to cover future legal expenses in the event of a default.  But the terms of the note and the stipulated facts provide no basis for contemplating damages in excess of the interest lost as a result of the breach.  No one has presented or argued any circumstances that would suggest the provision is compensatory rather than punitive.

It is well established that when the breached contract involves only the payment of money, the damages are susceptible of definite measurement.  See, e.g., id. at 210, 225 N.W. at 19 (classifying nonpayment of money as susceptible to precise measurement); Maudlin v. Am. Sav. & Loan Ass'n, 63 Minn. 358, 367, 65 N.W. 645, 649 (1896) (holding that damages from breach of contract for payment of money is susceptible to definite measurement).  Thus we perceive no basis on which to conclude that damages would not be susceptible to definitive measurement.

The final consideration, the reasonableness of the stipulated damages amount, is generally decisive in determining whether the provision is liquidated damages or penalty.  Stanton v. McHugh, 209 Minn. 458, 461, 296 N.W. 521, 523 (1941).  If damages for breach are susceptible to definite measurement, an amount "greatly disproportionate" to the actual damages is a penalty.  Costello v. Johnson, 265 Minn. at 210, 121 N.W.2d at 79. 

Under the terms of the promissory note, Stuebner is obligated to pay $50,000 for failure to make timely payments on a promissory note for $50,000.  In light of the nature of the contract and the precision with which money damages could be calculated, the $50,000 amount triggered by a default of payments on a note of equal value was properly designated as a penalty.  The actual damages resulting from the breach of the promissory note are the interest lost as a result of the breach plus the balance due on the note and any attendant costs of collection.  Because the "contract" at issue is an instrument with a facial amount of $50,000, a $50,000 sum for breach of its terms is conclusively a penalty.

            Reversed.