The opinion of the court was delivered by: Garibaldi, J.
On certification to the Superior Court, Appellate Division, whose opinion is reported at 313 N.J. Super. 525 (1998).
This appeal involves a $1.5 million dollar loan made by MetLife Capital Corporation, predecessor in interest to plaintiff MetLife Capital Financial Corporation ("MetLife"), to defendant Washington Avenue Associates, L.P. ("Washington Avenue") The loan was secured by a Mortgage and Security Agreement on a commercial property in Belleville, New Jersey. Numerous payments on the loan were delinquent, and Washington Avenue ultimately defaulted on the final "balloon payment." We now consider whether the five percent late charge assessed against each delinquent payment, and the default rate of interest, constitute reasonable stipulated damages provisions.
Washington Avenue executed a four-year promissory note as evidence of its debt to MetLife. The note required Washington Avenue to make forty-eight equal monthly payments of $14,030.98, and a final "balloon payment" of $1,391,236.90, due at the end of the four-year term. The promissory note provided that "a late fee equal to the lesser of five percent (5%) of the delinquent payment or the highest late charge permitted by law shall be payable with respect to any payment which is not paid within ten (10) days of the date on which it was due."
In the event of a declaration of default, the note provided that the interest rate on the unpaid principal balance would not be the non-default interest rate of 9.55 percent, but rather a default rate. The default rate was defined as "the greater of five percent (5%) per annum in excess of the `prime rate' as designated by Chase Manhattan Bank, N.A., from time to time, or fifteen percent (15%) per annum; provided, however, that such Default Rate shall not exceed the maximum rate allowable under law." On default, Washington Avenue also agreed to pay collection costs, including but not limited to MetLife's reasonable attorneys' fees, and to allow MetLife to possess the property, collect unpaid rents, and "apply the same, less costs and expenses of the operation of the Property . . . to the payment of any of the Secured Obligations, in such order as Grantee may determine."
When the loan was made, the mortgaged premises were leased by Washington Avenue to Walgreen Eastern Co., Inc. under a thirty-year lease. At all times during the life of the loan, the rent under the Walgreen lease was greater than Washington Avenue's monthly mortgage payments to MetLife.
Although Washington Avenue eventually made all forty-eight payments, forty payments were delinquent. The record does not indicate precisely how late Washington Avenue was with each of the payments. Washington Avenue also failed to make the balloon payment at maturity. MetLife declared the loan in default and began to collect the rent directly from the tenant.
MetLife commenced a foreclosure action against Washington Avenue, and its general partner Laurence S. Berger. *fn1 Washington Avenue filed an answer, challenging, among other things, the five percent late fee and the fifteen percent default rate. MetLife moved for summary judgment, and sought to strike Washington Avenue's counterclaims as non-germane. See R. 4:64-5. The court granted MetLife's motion, and concluded that the only germane counterclaims were the challenges to the late fees and default rate of interest. Thus, the court ordered the foreclosure to proceed as an uncontested action under R. 4:64-1 subject to an evidential hearing to determine the validity of the late fees and default rate of interest.
The hearing was held in February 1997. At the outset, the court, relying on Utica Mut. Ins. Co. v. DiDonato, 187 N.J. Super. 30 (App. Div. 1982), held that MetLife bore the burden of proving the enforceability of the stipulated damages clauses. Barbara Geer, Portfolio Management Specialist for MetLife, testified at the hearing. Geer testified that a five percent late fee was the industry custom and standard, and represented an estimate of the internal costs of administering late payments. She testified that MetLife has a department that handles delinquent payments. Employees in that department attempt to collect late payments by writing letters and making telephone calls. In addition to those duties, there are reporting and monitoring functions that must be fulfilled with respect to senior management and to other bank departments, among them the accounting, real estate, and legal departments. She claimed that internal cost calculations had been performed for other loans, but had not "been able to be totally conclusive." Geer also testified that the default interest rate was intended to compensate MetLife for losses resulting from increased administrative costs, lost investment opportunities, the need for appraisals and environmental studies, litigation costs and attorneys' fees. Geer was unable to quantify any of those losses, and noted that internal costs are difficult to establish conclusively.
Washington Avenue produced rebuttal testimony from Edward G. Morran, an experienced bank loan officer. Morran testified that in the event of a late payment a loan officer typically made a short phone call to the borrower and waited for payment. In his experience, the loan officer was the only person involved in collection efforts until the payment was several months overdue. Thus, the costs of administering a late payment were minimal. He also testified that the administrative costs of administering a loan did not vary with the principal amount. However, Morran did testify that the financial institution where he worked generally charged default rates of interest in the four to six percent range on all of its loans.
The court concluded that the five percent late fee represented reasonable liquidated damages. The court considered the default rate a penalty; however, it concluded that a default rate of 12.55 percent, three percent above the contract rate of 9.55 percent, was reasonably related to actual damages.
The court referred the case to the Foreclosure Unit of the Superior Court Clerk's Office for entry of final judgment. MetLife filed the required proof of the amount due as of March 31, 1997. See R. 4:64-2. That proof asserted that, in addition to the principal balance due, the late fees and default rate, the judgment should include 12.55 percent interest on property taxes paid by MetLife after default, but before final judgment. MetLife also accorded Washington Avenue a credit of $188,615.50 for rent collected directly from the tenant. MetLife sought a judgment of $1,453,183.91, inclusive of all charges and credits, Washington Avenue wrote to object to the rent credit calculation; however, its objection was not received until after the Foreclosure Unit had entered a final judgment of foreclosure based on MetLife's filed certification of proof.
Washington Avenue filed a motion for reconsideration, for relief from the foreclosure judgment, and to vacate or modify the credits for rents collected by MetLife. The court denied that motion. To preserve its rights and avoid a sheriff's sale of the property, Washington Avenue paid MetLife the full amount of the obligation in accordance with the judgment of foreclosure and repossessed the property.
Washington Avenue filed a notice of appeal, challenging the late fees and the default interest rate, and claiming additional credit for the rents collected by MetLife. MetLife did not cross-appeal the court's decision to lower the default interest rate to 12.55 percent. The Appellate Division reversed the trial court and concluded that both the five percent late fee and the default interest rate of 12.55 percent constituted unenforceable penalties. MetLife v. Washington Ave. Assoc., 313 N.J. Super. 525, 545 (1998). The court noted that the trial court improperly placed the burden of proving reasonableness on MetLife, but because MetLife did not appeal that ruling and because "the factual proofs were largely undisputed," the court considered the misplacement of the burden of proof "inconsequential." Id. at 538.
The court assessed the enforceability of the five percent late fee under the two-pronged test promulgated in Westmount Country Club v. Kameny, 82 N.J. Super. 200, 206 (App. Div. 1964). First, the court considered if the late charge was reasonably related to the anticipated or actual damages to be suffered by the lender from the delay in payment. Ibid. Second, the court considered if those damages were difficult to establish. Ibid. The court held that the first requirement was not satisfied, because the five percent late charge was unrelated to the duration of the breach or amount of the installment. Id. at 540-41. The court concluded that MetLife's collection costs would be the same regardless of the size of the payment or duration of the breach. Ibid. The court also held that the second requirement was not satisfied, because collection costs and the value of the loss of use of the late payment could easily be calculated. Id. at 541-42. The court rejected the default interest rate for the same reasons, and held that the trial court's adjustment to 12.55 percent was entirely speculative. Id. at 544-45. Finally, the court held that MetLife's failure to credit the rents to Washington Avenue's outstanding obligations as collected, or credit Washington Avenue with interest on the total sum collected, violated the implied covenant of good faith and fair dealing that inheres in every contract. Id. at 534.
Accordingly, the court vacated the judgment of foreclosure allowing the five percent late fees and the 12.55 percent default rate and remanded the matter to permit MetLife to present proof of the actual damages sustained by reason of the late payments and the default. Id. at 545. The Appellate Division also remanded the case for a recalculation of the rent-credit.
We granted MetLife's petition for certification. 156 N.J. 427 (1998).
Historically, courts have closely scrutinized contract provisions that provided for the payment of specific damages upon breach. Wasserman's Inc. v. Middletown, 137 N.J. 238, 248 (1994). The need for close scrutiny arises from the possibility that stipulated damages clauses may constitute an oppressive penalty. Enforceable stipulated damages clauses are referred to as "liquidated damages," while unenforceable provisions are labeled "penalties." Ibid. ...