4th Circuit: Doral Bank v. Federal Home Loan Mortgage Corporation- Enforceability of Liquidated Damages Provisions

Summary: Doral agreed in an Interim Servicing Agreement ("ISA") to take over servicing of Federal Home Loan Mortgage Corporation ("Freddie Mac") mortgages previously serviced by R&G Mortgage Corp.  (R&G).  R&G, however, successfully block this assignment.  Even though it never actually serviced these mortgages and incurred actual costs of only $124,588.00,  Doral then sought 24-months of servicing fees as compensation, as required under the ISA.  Freddie Mac argued that Doral was not entitled to such fees, as Freddie Mac had never determined and communicated to Doral by a separate communication the effective date on which Doral would commence servicing the mortgages. Agreeing with the district court, the 4^th Circuit found both that the ISA required a specific notice of the effective date of servicing and also that the enforcement of 24-months of servicing fees would not "reasonably forecast Doral’s loss", as it was over 87 times the actual damages.  A liquidated damages provision is unenforceable if it is intended to punish a party for a breach, rather than compensate the aggrieved party for its actual damages.  The $10 million dollars in servicing fees would represent both a punitive award and a massive windfall, since Doral would obtain such an amount without incurring any of the servicing costs it would have otherwise had if it actually serviced the mortgages. The dissent, however, found that the 24-month term for servicing fees was a much more nuanced and negotiated provision, since Freddie Mac had insisting that the ISA be terminable on 30-days notice (which might have been done to remove the Freddie Mac’s liability for these mortgages by transferring them to a permanent servicer) and Doral had wanted to protect its large initial expense of taking over the servicing of these mortgages.  As such, the Judge Davis would have found this to be a provision for  "alternative performance"  and not a liquidated damages, enforceable or otherwise. For a copy of the opinion, please see: Doral Bank v. Federal Home Loan Mortgage Corporation- Enforceability of Liquidated Damages Provisions.PDF