## Facts

- A borrower obtained a real-estate-secured loan from a thrift and loan association.
- The loan terms included an interest rate and a substantial loan fee (points) paid in connection with originating the loan.
- The loan documents included a clause that, upon specified payment defaults and a subsequent payoff or refinancing, allowed the lender to retain a large portion of the loan fee or collect an additional fixed charge.
- The amount imposed was substantial, fixed, and not tied to any showing of the lender’s administrative costs or actual loss caused by the borrower’s breach.
- The borrower challenged the clause as an unlawful penalty under California Civil Code § 1671 rather than an enforceable liquidated-damages term or valid prepayment/interest provision.

## Issues

1. Whether a loan provision that becomes operative upon default and requires the borrower to forfeit or pay a substantial fixed sum is an unenforceable penalty under California Civil Code § 1671.
2. Whether labeling a default-triggered charge as a “loan fee,” “late charge,” or “prepayment” term prevents penalty review when the clause’s economic operation is punitive rather than compensatory.
3. What remedy is available when a lender has retained money pursuant to a void penalty provision.

## Decision

- The Supreme Court of California reversed enforcement of the challenged provision.
- The Court held the fee-retention/default charge was an unenforceable penalty under Civil Code § 1671 because it lacked a reasonable relationship to anticipated damages from the breach.
- The Court rejected the argument that the provision was insulated from penalty analysis merely because it was framed as part of loan pricing or a prepayment term.
- The borrower was entitled to restitution of amounts retained solely under the invalid provision, while the remainder of the loan agreement remained enforceable.

## Legal Principles

- Under California Civil Code § 1671, a stipulated-damages clause is unenforceable if the amount set bears no reasonable relationship to the range of actual damages the parties could have anticipated from breach at the time of contracting.
- Courts evaluate the substance and operation of a challenged charge; contractual labels do not control if the clause functions as a default sanction.
- A charge that is triggered by default and imposes a disproportionate, fixed payment untethered to anticipated harm is a penalty and void, including in commercial lending transactions.
- A valid prepayment premium or interest-related term must function as a legitimate yield-protection measure rather than a punishment for breach.
- When a penalty provision is void and money has been collected under it, restitution is available for sums retained by virtue of the unlawful clause.

## Conclusion

The court treated the lender’s default-contingent fee-retention term as a penalty because it operated as a substantial, fixed sanction without a reasonable relationship to anticipated losses, rendering it unenforceable under Civil Code § 1671 and permitting restitution of amounts collected under that provision.


Ridgley v. Topa Thrift & Loan Ass'n, 17 Cal. 4th 970 (Cal. 1998)