Direct Transit, Inc. v. South Dakota Governor's Office of Economic Development (In Re Direct Transit, Inc.)Direct Transit, Inc. v. South Dakota Governor's Office of Economic Development (In Re Direct Transit, Inc.)
The Debtor, Direct Transit, Inc. (“Direct Transit”), appeals an order of the bankruptcy court 2 allowing the inclusion of liquidated damage in the calculation of a secured claim filed by the South Dakota Governor’s Office of Economic Development (“GOED”). We affirm.
I
BACKGROUND
The parties do not dispute the facts in this case, which they submitted to the bankruptcy court by stipulation. The State of South Dakota has established an incentive program to stimulate economic development in the state referred to as the “Revolving Economic Development and Initiative Fund” (REDI). GOED administers the fund, the mission of which is to invest taxpayer dollars to create new primary jobs and quality job opportunities for South Dakotans through low interest loans to qualified applicants. Between 1989 and 1996 more than 10,000 primary jobs were created with the use of REDI funds.
GOED lent REDI funds to Direct Transit under two loan packages. Loan Package # 91-05-A in 1992 was for the sum of $200,-000.00 at 3% interest, and Loan Package # 94^-21-A in 1995 was for the sum of $500,-000.00 at 2% interest. A promissory note memorialized each loan. Tо secure the two loans, GOED took a mortgage on Direct Transit’s new headquarters, a security interest in the personal property located there, and a $450,000.00 demand letter of credit. The mortgage and security interests were properly perfected.
In addition to the loan packages, the parties entered into sepаrate employment agreements. These agreements specified, among other things, that the applicant must maintain its business operation in South Dakota for eight years from the date of the agreement without the loss to South Dakota of “the employment created by the project.” (App. to Appellant’s Brief at 26, 37.) Although the emрloyment agreements were binding for a term of eight years, the promissory notes were amortized over a shorter, five-year period in equal monthly installments.
Each employment agreement contained a provision that if the borrower ceased operation within eight years from the date of the agreement, the borrower agrеed to pay liquidated damages. The agreement fixed liquidated damages as the difference between the interest rate in the note and an interest rate that the parties agreed was the current commercial rate, 10% in 1992 and 8% in 1995.
Competent legal counsel represented both Direct Transit and GOED at the time the employment agreements were signed. The parties negotiated extensively regarding the terms of the agreements, and the officers who signed the agreements on behalf of Direct Transit are experienced businessmen.
Direct Transit filed for relief under the provisions of chapter 11 of the Bankruptcy Code on October 21,1996. The parties have stipulated that Direct Transit breached the employment agreement on April 8, 1997. GOED’s claim is fully secured, including that disputed рortion of the claim for liquidated damages. Unsecured creditors in this case will receive less than a 100% dividend. A distribution to equity security holders is unlikely.
The amount of liquidated damages, measured by the difference in the contract rate of interest and the market rate of interest, is $104,851.00. GOED’s secured claim, if all liquidated damages are allowed, is calculated as follows:
Principal $171,909.97
Interest through 2/15/98 $ 15,032.80
Liquidated Employment Damage $104,851.00
TOTAL: $291,793.77
Per Diem on Principal $ 54.16
Balance only on and after
February 15,1998
II.
BANKRUPTCY APPELLATE PANEL JURISDICTION
Direct Transit filed a timely notice of appeal, and neither party elected to submit the appeal to the District Court. Therefore, this panel has jurisdiction pursuant to 28 U.S.C. § 158(a)(1); 28 U.S.C. § 158(b)(6); and 28 U.S.C. § 158(c).
III.
ISSUE AND STANDARD OF REVIEW
The issue is whether the liquidated damage provision of the employment agreements is enforceable under South Dakota law and prоperly included in the secured claim of GOED pursuant to 11 U.S.C. § 506(b). Because the issue is a question of law, we review the bankruptcy court’s ruling
de novo. First Nat’l Bank of Olathe v. Pontow,
IV.
ARGUMENTS
As a basis for reversal Direct Transit argues two points. The first argument is that, despite its characterization as liquidated damages, the disputed portion of the claim results from a default interest rate retroactively applied and is, therefore, not allowable. The second argument is that even if the claim includes liquidated damages rather than default interest, it is unenforceable under South Dakota law because the amount of liquidated damages is “vastly disproportionate to the injury [from the breach and, thus,] unreasonable and unenforceable.” (Appellant’s Brief at 5.)
V.
DISCUSSION
The Bankruptcy Code provides that an over-secured creditor may claim principal and interest due on the date the petition is filed, as well as post-petition interest and “any reasonable fees, costs or charges provided for under the agreement under which such claim arose.” 11 U.S.C. § 506(b) (1994). The parties stipulated that Direct Transit is over-secured to the full extent of the amount of the claim, including the disputed charge for liquidated damages, and that if the liquidated damages claim is allowable, it is a properly perfected secured claim.
We hold that the term of the employment contract in question is a true liquidated damages provision, that it is enforceable under South Dakota law, and that it is a reasonable charge and properly allowable as part of GOED’S secured claim pursuant to 11 U.S.C. § 506(b).
Direct Transit first argues that the liquidated damage provision in each employment agreement is a default rate of interest that is unenforceable because such interest cannot be retroactively applied. In determining whether to enforce default interest terms, some courts view such increases as a species of liquidated damages rather than distinguishing between the two.
See, e.g., In re Timberline Property Dev., Inc.,
Although default interest and liquidated damages are similar in concept, the differences between the two are readily discernible, especially when applied to the facts in this case. When the term “default interest” is used, “default” refers to an event in a debtor-creditor relationship that triggers certain consequences typically set out in a loan document.
Citybank v. Udhus (In re Udhus),
Here, the calculation for liquidated damages is located in each Agreement Relating to Employment but not in the promissory notes or other loan documents where provisions for default interest rates typically are found. The disputed increase in interest is labeled “liquidated damages,” and the parties expressly agreеd that Direct Transit would pay GOED a specific sum in the event of breach of the Loan Authorization. Under this agreement, the specified liquidated damages are only due if Direct Transit changed the nature of the project, relocated, or ceased operations so that a loss of employment resulted. Other than the contract rates of interest of 3% and 2%, the only interest rate referred to by the two promissory notes is interest on past-due payments. Direct Transit could have been in default under .the terms of the notes without being liable for liquidated damages if Direct Transit continued to operate consistent with the Agreements Related to Employment.
The liquidated damagеs provision became due for a non-monetary breach of the contract rather than for a default under the terms of the note. Therefore, the provision in question is a true liquidated damages provision and not a default rate of interest.
B. THE LIQUIDATED DAMAGE PROVISION IS ENFORCEABLE UNDER STATE LAW AND THE BANKRUPTCY CODE
The analysis as to the allowance of liquidated damages begins with section 506(b). That provision allows for a claim to include additional charges if the claim is over-secured, the charge is provided for under the agreement under which the claim arose, and the charge is reasonable. 11 U.S.C. 506(b) (1994). Additionally, the charge must be enforceable under state law.
Mack Fin. Corp. v. Ireson,
Any contract in which the amount of damages or compensation for breach of an obligation is determined in anticipation thereof is void to that extent except the parties may agree therein upon an amount presumed to be the damages for breach in cases where it would be impracticable or extremely difficult to fix actual damage.
S.D. Codified Laws § 53-9-5 (Michie 1998).
Like the laws of many other jurisdictions, South Dakota law sustains a provision for liquidated damages if (1) at the time the contract was made the damages in the event of breach were incapable or very difficult of accurate estimation; (2) there was a reasonable endеavor by the parties to fix fair compensation; and (3) the amount stipulated bears a reasonable relation to probable damages and not disproportionate to any damages reasonably to be anticipated.
Safari, Inc. v. Verdoom,
South Dakota decisions mirror the modern trend to enforce reasonable liquidated damage provisions in contracts.
Prentice v. Classen,
If the purрose of liquidated damages is to ensure performance of the contract with an
in terrorem
provision, then liquidated damages may well be construed as an unenforceable penalty.
Hofer,
Liquidated damage provisions are particularly useful in public contracts when damages are uncertain or unmeasurable.
City of Fargo,
The bankruptcy court correctly applied the law to the facts in this case and was correct in declining to rewrite the contract the parties negotiatеd. First, the damages in the event of Direct Transit’s breach were incapable of accurate estimation. Direct Transit does not directly dispute this point. Incalculable damages were sustained by the
Second, the parties made a reasonable effort to fix fair compensation, a conclusion well established by the record. The parties stipulated that the employment contracts were the products of extensive negotiations by experienced businessmen represented by competent legal counsel.
Third, the amount stipulated bears a reasonable relation to probable damages and is not disproportionate to any damage reasonably to be anticipated. The benefit of the bargain received by Direct Transit was a loan at a rate of interest below market rates. Direct Transit argues that the liquidated damage provision does not credit Direct Transit with having provided bargained-for consideration to GOED for a portion of the eight-year terms. Direct Transit emphasizes that the longer it performed, the greater the liquidated damage amount when the company ceased to perform under the agreements. Thus, Direct Transit argues that the liquidated damage provision bears no reasonable relation to the actual damage to be anticipated.
This argument focuses on only one aspect of the complete picture. The parties stipulated that the market rate of interest provision was “compensation for the loss of income the loan funds could be making in the commercial investment market.” (App. to Appellant’s Brief at 48.) The longer Direct Transit had use of the loan proceeds at a below-market rate of interest, the greater thе detriment to GOED, and the greater the benefit to Direct Transit. As previously stated, the damages for breach of the employment contracts were impossible to calculate; therefore, the parties agreed that the damages would equal the actual time value of the borrowed money. This stipulated amount is not unconscionаble in view of the value of the subject matter of the contract and GOED’s loss because of the breach.
Hofer v. W.M. Scott Livestock Co.,
Direct Transit’s argument seems to be that the stipulated sum should not be enforced because the parties did not more accurately estimate actual damages. In support of this contention, Direct Transit asserted in oral argumеnt that the liquidated damage amount was probably lower than the actual damages suffered. Thus, because the parties did not initially agree to a greater amount, the liquidated damages are disproportionately low and the liquidated damages provision fails the third prong of the test.
However, as is typical in public contracts wherе the public as a whole will suffer from a breach, the parties irr this case could not, at the time of the agreements, and cannot now quantify the resulting damages. The parties therefore attempted to accomplish the purpose of any reasonable liquidated damages provision: “[T]o avoid the waste of controversy as to the extent of a loss, should it occur, and to save judges and jurors from having to guess about it....”
Priebe & Sons, Inc. v. United States,
The fact that a charge is enforceable under state law is at least indicative of its reasonableness under the Bankruptcy Code.
See, e.g., Mack Fin. Corp. v. Ireson,
Although the damages in this case are impossible to quantify, thе evidence adequately demonstrates that damages occurred as a result of the breach of contract, and the stipulated damages provide GOED at least some measure of recovery because GOED did not receive the benefit of its bargain: jobs for South Dakotans for eight years in exchange for a low interest loan. Therefore, the charges are reasonable within the meaning of section 506(b). Under the facts in this case, the Bankruptcy Court was correct in declining to rewrite the contract the parties negotiated.
VI.
CONCLUSION
Therefore, for the reasons stated the judgment of the bankruptcy court is affirmed.
Notes
. The Honorable William L. Edmonds, Chief Judge, United States Bankruptcy Court for the Northern District of Iowa.