Daily Development for Monday, March 5, 2007
by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri
VENDOR/PURCHASER; INSTALLMENT SALES CONTRACTS; REMEDIES: Liquidated damages provision in installment sales contract not unreasonable if the potential forfeiture is only around 14% of the total contract price. .
Thomas v. Scarborough, No. 2005-CA-02137-COA, 2006 WL 3290833 (Miss. Ct. App., Nov. 14, 2006).
Thomas and the Scarboroughs entered into a contact in 2001 under which Thomas, as owner of property in Rankin County, leased the property to the Scarboroughs for 48 months. The Scarboroughs paid $30,000, which was identified as a 'Prior Equity Credit", when the contract was signed. They had the option to purchase the property at the end of the lease for $54,815. Taken together with an annual lump sum payment to Thomas and other adjustments, the total paid by the Scarboroughs to Thomas would be $224,900. The contract provided in part, "If a forfeiture is enforced at the sole option of the Lessor, Lessee shall forfeit all rights and interest in and to the Property and …shall forfeit all payments made hereunder…"
The lease payments were $1500 per month, plus $5, 480 per year “additional rent.” Lessee paid a $1750 security deposit and agreed to pay all property taxes during the term of the lease.
The Scarboroughs breached the agreement in 2004 by failing to pay rent. They vacated the premises and requested that Thomas refund the $30,000 Prior Equity Credit. Thomas refused to do so. The Scarboroughs filed a lis pendens against the property. When Thomas went to sell the property, she agreed with the Scarboroughs to escrow $22,141.57 (the $30,000 Prior Equity Credit less past due rent and other charges owed by the Scarboroughs) in exchange for the release of the lis pendens.
Thomas and the title company then interpled the $22,141.57. The Scarboroughs argued that the contract was ambiguous and that the contract contained an unreasonable liquidated damages provision that was unenforceable under Miss. Code Ann. § 75-2-718(1), which is part of Mississippi's version of the Uniform Commercial Code. Section 75-2-718(1) provides, "Damages for breach by either party may be liquidated in the agreement but only at an amount which is reasonable in the light of the anticipated or actual harm caused by the breach, the difficulties of proof of loss, and the inconvenience or nonfeasibility of otherwise obtaining an adequate remedy. A term fixing unreasonably large liquidated damages is void as a penalty."
The Chancery Court of Rankin County held that Thomas had suffered no loss since she had sold the property for a profit, and that an award of the interpleader fund to Thomas would constitute an unconscionable penalty under Section 75-2-718(1). Thomas appealed.
The Court of Appeals, in a unanimous decision by Justice Myers, reversed and rendered judgment for Thomas. The court first determined that the contract was not ambiguous. The court then determined that Section 75-2-718(1) was the applicable standard. The Mississippi Supreme Court had used Section 75-2-718(1) as the standard for determining the enforceability of a liquidated damages provision in a contract for the purchase and sale of the land in Maxey v. Glindmeyer, 379 So. 2d 301 (Miss. 1980). In that case the court held that a forfeiture of a $75,000 down payment on a contract with a total purchase price of $150,000 was unconscionable and an unenforceable penalty. In the current case, the court noted, the $30,000 Prior Equity Credit was only approximately 14% of the total purchase price of $224,900. In comparison to the 50% penalty in the Maxey case, this was not unconscionable.
The Court of Appeals also found that the trial court had miscalculated Thomas' loss from the sale. If the Scarboroughs had fulfilled their obligations under the lease and purchased the property at the end of the term, Thomas would have made a profit of $86,443. Her profit on the sale that she made was only $46,886, not including the $22,141.57. The court found it significant that the only way that Thomas would be compensated for her loss was from the interpleaded funds.
Reporter’s Comment 1: These kinds of lease purchase agreements, a variation of an installment sales contract, are rarely used in Mississippi. This case illustrates why. What well advised buyer would enter into such an of agreement? The lessee/buyers in this case lost their $30,000 Prior Equity Credit/downpayment and some other payments, and probably attorney’s fees in trying to get their money back.
Such arrangements are fraught with other potential problems: for example, what happens if the lessor/seller dies or files bankruptcy after the lessee/buyer has made substantial payments? While undoubtedly other relevant facts exist that are not part of the published opinion, if lessee/buyers had $30,000 in cash to put down, it seems that they could have gotten a conventional home loan from a bank instead of entering into this squirrelly deal.
Reporter’s Comment 2: But, given the fact that buyers did in fact enter into this contract, it's tough to make an argument that the contract that one has agreed to is unreasonable and shouldn't be enforced. It's especially hard to make that argument based on what's “reasonable” when you've breached the lease agreement by failing to make the payments that you promised to pay. In the Maxey v. Glindmeyer case, cited by the Court of Appeals in Thomas, the sales contract, prepared by an "attorney real-estate broker in Milwaukee," was world-class sloppy, and the seller and purchaser were mutually mistaken about the amount of acreage involved. Also, in the Maxey case, the seller did not have a subsequent sale to establish actual damages. So the equities in that case were more balanced.
Reporter’s Comment 3: The editor has a knee-jerk reaction against using the UCC as a basis for filling in holes in real property law, because important principles of real property law such as title and constructive notice are generally not taken into account by the UCC. In this case, however, the most common statement of the common-law rule, and one that has been used by federal courts in diversity cases applying Mississippi law - Section 356(a) of the Restatement of Contracts - is almost identical to the Mississippi version of Section 2-718(1). Section 356(a) provides, "Damages for breach by either party may be liquidated in the agreement but only at an amount that is reasonable in light the anticipated or actual loss caused by the breach and the difficulties of proof of loss. A term fixing unreasonably large liquidated damages is unenforceable on grounds of public policy as a penalty." So at least in this case, the use of the UCC rather than the common law does not make a diff
erence in the result.
Reporter’s Comment 4: Mississippi's version of Section 2-718(1) is the same as the uniform version promulgated by the National Conference of Commissioners of Uniform State Laws and the American Law Institute prior to 2003. In 2003 NCCUSL and ALI promulgated amendments to Article 2 of the UCC. These amendments, among other things, inserted the words "and, in a consumer contract," in the first sentence of Section 2-718(1), so that the first sentence of the uniform version reads, "Damages for breach by either party may be liquidated in the agreement but only at an amount which is reasonable in the light of the anticipated or actual harm caused by the breach, and, in a consumer contract, the difficulties of proof of loss, and the inconvenience or nonfeasibility of otherwise obtaining an adequate remedy." The 2003 amendments also drop the last sentence of Section 2-718(1), which provides, "A term fixing unreasonably large liquidated damages is void as a penalty." However, Mississippi
has not adopted the 2003 amendments to Article 2. In fact, the editor's quick research suggests that no state has adopted the 2003 amendments. What's up with this?
Editor’s Comment: In the world of installment land contract remedies, and mortgage remedies in general, there’s really nothing unusual about a borrower arguing that the lender’s remedies are overreaching. The whole basis for the creation of the equity of redemption is that real estate purchasers frequently do not focus clearly on the remedies section of the agreement, while lenders and sellers do - leading to an inherent imbalance in bargaining. Throughout the country, courts routinely set aside forfeitures in installment land contracts in a wide range of circumstances. In fact, outside of a few states - Minnesota, Michigan, and possibly New Mexico, to name a few, enforcement of installment land contracts as written is hardly the norm - it is the exception.
The editor read the original version of this case, and admits to a great deal of frustration in the court’s opinion. It does not tell us the relationship between the apparently hefty “rental” payments and the market rent. (The credit that the seller took in the agreement to escrow the $30,000 included claims for accrued but unpaid “additional rent” plus an amount for some unpaid property taxes.) It does not tell us why it was a reasonable “liquidated damages” agreement for the seller to take a $1750 “security deposit” when it already had a forfeitable $30,000. It does not tell us the price that the seller received for the property on resale, nor the method by which it computed the profit (did it count all the “rental” payments as payments on the price? Even “effective interest” components?) It also does not tell us why the lower court figured the profit differently.
In short, what we have is a virtually unintelligible piece of precedent that will mislead and confuse trial court judges while contributing nothing to a workable approach to this difficult and controversial real estate device. Not what the editor has come to expect from Mississippi, where you always get a good story and often some reasonably sound analysis.
The reporter for this case was Rod Clement of the Jackson, Mississippi, Bar. .
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