## Facts

- Borrowers brought a class action against a savings and loan association challenging “late charges” imposed under uniform promissory note terms secured by deeds of trust.
- The notes provided that if a payment was in default, the lender could charge “additional interest” at 2% per year on the entire unpaid principal balance for the period of default until payment cured the default.
- When an installment was late, the lender allegedly assessed the charge as a percentage of the entire unpaid principal balance, rather than as a fee tied to the delinquent installment or actual collection costs.
- Plaintiffs alleged the charge operated as liquidated damages for late payment and was void as a penalty under Civil Code § 1670 (subject to the § 1671 exception).
- Plaintiffs alleged thousands of borrowers paid substantial aggregate late charges within the limitations period.
- The trial court sustained the lender’s general demurrer without leave to amend and dismissed; plaintiffs appealed.

## Issues

1. Whether a late-charge provision triggered by late payment, though labeled “additional interest,” is properly treated as a liquidated-damages clause subject to Civil Code §§ 1670–1671.
2. Whether plaintiffs stated a claim that calculating the charge on the entire unpaid principal balance could be an unenforceable penalty because it lacked a reasonable relationship to the lender’s probable loss from late payment.
3. On demurrer, whether the court could determine as a matter of law that the clause satisfied § 1671 (impracticability of fixing actual damages and reasonable preestimate).

## Decision

- Reversed the dismissal and held the complaint stated a cause of action.
- Treated the demurrer as admitting well-pleaded material facts and addressed only legal sufficiency.
- Held the challenged charge, as alleged, was imposed only upon default and therefore functioned as liquidated damages rather than ordinary interest.
- Concluded it could not be determined on the pleadings that a charge based on the entire principal balance reasonably approximated anticipated damages from a late installment, or otherwise satisfied § 1671.
- Remanded for further proceedings.

## Legal Principles

- Contractual charges imposed only upon breach are evaluated by substance, not labels, and may be treated as liquidated damages even if called “interest.”
- Under Civil Code §§ 1670–1671 (as then in force), stipulated damages are unenforceable if they operate as penalties rather than a reasonable estimate of anticipated harm where actual damages are impracticable or extremely difficult to fix.
- A stipulated sum must bear a reasonable relationship to the range of damages the parties could have anticipated from the breach; a provision primarily aimed at coercing timely performance is invalid.
- On demurrer, courts do not resolve factual questions about reasonableness or difficulty of ascertaining damages when the complaint alleges facts supporting penalty characterization.

## Conclusion

The court allowed borrowers to proceed on a claim that a lender’s late charge computed on the entire unpaid loan balance, triggered by late installments, could be an unlawful penalty under California’s liquidated-damages statutes, making dismissal at the pleading stage improper.


Garrett v. Coast & S. Fed. Sav. & Loan Ass’n, 9 Cal. 3d 731, 511 P.2d 1197 (Cal. 1973)