JMD Holding Corp. v. Congress Financial Corp., 4 N.Y.3d 373 (2005)

A contractual provision for liquidated damages will be enforced if the amount is a reasonable estimate of probable loss and the actual loss is difficult to determine; the party challenging the clause bears the burden of proving it is a penalty.

Summary

JMD Holding Corp. sued Congress Financial Corp. to recover $600,000 charged as an early termination fee under a $40 million commercial revolving loan agreement, and for the return of funds held as a cash collateral reserve. JMD defaulted on the loan agreement, leading Congress to terminate the agreement and demand the early termination fee. JMD argued the fee was an unenforceable penalty. The court held that JMD failed to prove the fee was a penalty because it did not demonstrate that damages were easily ascertainable at the time of contract or that the fee was disproportionate to foreseeable losses. The court also found that Congress was not entitled to retain the cash collateral reserve.

Facts

JMD entered into a loan and security agreement with Congress for a $40 million revolving line of credit. The agreement included an early termination fee of 1% to 2% of the maximum credit line, decreasing as the term approached expiration. JMD defaulted on several provisions of the agreement, including collateral reporting, minimum working capital, and delivering required documentation. Congress notified JMD of the default, accelerated the debt, and demanded immediate repayment, including the $600,000 early termination fee (1.5% of $40 million). JMD eventually paid the loan balance but Congress retained funds as a cash collateral reserve.

Procedural History

JMD sued Congress, arguing that the early termination fee was an unenforceable penalty and that Congress wrongfully retained the cash collateral. Supreme Court granted summary judgment to JMD, deeming the liquidated damages clause a penalty and finding no factual issues regarding the cash reserve. The Appellate Division affirmed. The New York Court of Appeals granted leave to appeal.

Issue(s)

1. Whether the early termination fee in the loan agreement constitutes an enforceable liquidated damages clause or an unenforceable penalty.

2. Whether Congress was entitled to retain funds from JMD’s loan account as a cash collateral reserve after JMD paid off its outstanding loans.

Holding

1. No, because JMD did not satisfy its burden of showing that the fee was an unenforceable penalty.

2. No, because the agreement did not authorize Congress to retain and charge a reserve for attorneys’ fees incurred related to disputes on the agreement.

Court’s Reasoning

The Court of Appeals stated that whether an early termination fee is an enforceable liquidation of damages or an unenforceable penalty is a question of law, giving due consideration to the nature of the contract and the circumstances. The burden is on the party seeking to avoid liquidated damages to show that the damages are, in fact, a penalty. Quoting Truck Rent-A-Center, the court reiterated that a liquidated damages provision is valid if “the amount liquidated bears a reasonable proportion to the probable loss and the amount of actual loss is incapable or difficult of precise estimation.” The court found that JMD failed to demonstrate that damages flowing from early termination were readily ascertainable when the agreement was made, or that the fee was disproportionate to foreseeable losses. JMD argued that Congress suffered no damages because JMD had the right, but not the obligation, to borrow. The court rejected this, noting that Congress had to maintain adequate funding to fulfill its lending commitment and suffered costs as a result, including limiting its ability to make loans to other entities. The court also found JMD’s breaches to be material, given the nature of a commercial revolving loan agreement, as JMD failed to provide Congress with necessary information to track the collateral and determine loan availability accurately.

Regarding the cash collateral reserve, the court found that Congress was not authorized to retain and charge a reserve for attorneys’ fees incurred in related disputes. The agreement allowed Congress to require cash collateral to secure itself against losses connected with contingent obligations, but this collateral was to be remitted by wire transfer by JMD. Here, Congress retained surplus proceeds as a reserve, which was not authorized by the agreement. The court noted that the question of whether Congress may recoup any of its attorneys’ fees by way of counterclaim or in a separate action for indemnification was beyond the scope of the Supreme Court’s reference to the special referee.