Judge Gregory Keosian, Case Number: 23STCP00972, Date: 2023-09-21 Tentative Ruling

Petitioner Antoine Souma’s and Respondents Respondents Morgan Stanley Smith Barney LLC and Morgan Stanley Smith Barney Financing LLC’s Motions to File Under Seal are GRANTED.

Respondents Morgan Stanley Smith Barney LLC and Morgan Stanley Smith Barney Financing LLC’s Motion to Confirm Arbitration Award is DENIED.

The court may order that a record be filed under seal only if it expressly finds facts that establish:

(1) There exists an overriding interest that overcomes the right of public access to the record;

(3) A substantial probability exists that the overriding interest will be prejudiced if the record is not sealed;

A party moving to seal records must make a sufficient evidentiary showing to overcome the presumed right of public access to the documents. (see Huffy Corp. v. Superior Court (“Huffy”) (2003) 112 Cal.App.4th 97, 108.)

Petitioner Antoine Souma and Respondent Morgan Stanley Smith Barney LLC both move to file under seal unredacted copies of the moving papers and declarations discussing the terms of a confidential settlement agreement between the parties.

Courts have found that confidentiality provisions in settlement agreements have been found to support an overriding interest in favor of sealing records. (See Universal City Studios, Inc. v. Superior Court (2003) 110 Cal.App.4^th 1273, 1283.) These courts have also found that this interest does not justify sealing documents absent a “specific showing of serious injury” resulting from the failure to seal. (McNair v. National Collegiate Athletic Assn. (2015) 234 Cal.App.4th 25, 35; Universal City Studios, Inc. v. Superior Court (2003) 110 Cal.App.4th 1273, 1282.)

Here, the motions to seal are supported by the declaration of Wendy R. Robinson, executive director of Morgan Stanley Smith Barney in the law and compliance division, who testifies that the terms of the settlement agreement here are subject to provisions of confidentiality, which Respondent negotiates for in its settlement agreements in order to preserve the confidentiality of the personal details contained in such agreements, as well as to maintain Respondent’s ability to negotiate settlements in future disputes with its employees. (Robinson Decl. ¶¶ 2–3.) The parties have shown that an overriding interest in the confidentiality of the documents exists, which will be prejudiced if they are not permitted to be filed under seal.

(4) The arbitrators exceeded their powers and the award cannot be corrected without affecting the merits of the decision upon the controversy submitted.

California public policy supports the use of private arbitration to resolve disputes. To promote this alternative means of dispute resolution, the law minimizes judicial intervention in the proceedings, in part, by the doctrine of arbitral finality. Thus, the general rule is that ‘an arbitrator's decision cannot be reviewed for errors of fact or law. Both because it vindicates the intentions of the parties that the award be final, and because an arbitrator is not ordinarily constrained to decide according to the rule of law, it is the general rule that, [t]he merits of the controversy between the parties are not subject to judicial review. More specifically, courts will not review the validity of the arbitrator's reasoning. Further, a court may not review the sufficiency of the evidence supporting an arbitrator's award.”

(Jones v. Humanscale Corp. (2005) 130 Cal.App.4th 401, 407–408, internal citations, quotation marks, and alterations omitted.)

Petitioner Antoine Souma (Petitioner) seeks to vacate the underlying arbitration award against him, in the amount of $6.39 million, on the grounds that the arbitrators exceeded their powers by enforcing a liquidated damages provision with the practical effect of an unenforceable penalty under Civil Code § 1671. Petitioner relies on the case Honchariw v. FJM Private Mortgage Fund, LLC (2022) 83 Cal.App.5th 893, 901, which held that “an arbitrator may exceed their powers by enforcing a contract that is in violation of public policy,” and thus that an arbitrator’s decision to enforce a provision over a challenge founded upon Civil Code § 1671 is subject to “de novo review.” Respondents Morgan Stanley Smith Barney LLC and Morgan Stanley Smith Barney Financing LLC (Respondents) present no contrary authority, and thus the court shall assess whether Civil Code § 1671 bars the award.

“[A] provision in a contract liquidating the damages for the breach of the contract is valid unless the party seeking to invalidate the provision establishes that the provision was unreasonable under the circumstances existing at the time the contract was made.” (Civ. Code, § 1671, subd. (b).) An exception exists under this provision for consumer contracts or residential leases. (Civ. Code § 1671, subd. (c).) Otherwise, the statute carries a “presumption that liquidated damage provisions in nonconsumer contracts are valid,” and thus “the party challenging the provision bears the burden to show the provision was unreasonable under the circumstances existing when the parties entered into the contract.” (Honchariw, supra, 83 Cal.App.5^th at p. 901.)

The underlying facts are as follows. Until July 2020, Petitioner was an employee of Respondents. (Robinson Decl. ¶¶ 2–3.) During his employment, Petitioner signed two promissory notes by which Respondents agreed to loan him $9.5 million and $1.1 million. (Robinson Decl. ¶¶ 4–5.) The notes contained provisions requiring the repayment of the outstanding balance, plus interest, if Plaintiff’s employment was terminated. (Robinson Decl. ¶ 6.) Respondents filed a FINRA arbitration claim against Petitioner in November 2020, seeking payment of the amounts owed after Petitioner’s employment terminated. (Robinson Decl. ¶ 10.) Petitioner filed counterclaims, which in the ultimate arbitration award are described as claims for defamation, promissory fraud, negligent misrepresentation, tortious and negligent interference with economic advantage, breach of contract, ERISA violations, unfair competition, violation of the covenant of good faith and fair dealing, and violation of FINRA Rule 2010. (Vanecek Decl. Exh. A.) Both Petitioner and Respondents were represented by counsel. (Vanecek Decl. ¶ 2.)

The parties temporarily resolved the above dispute by a confidential settlement agreement entered in March 2022. (Souma Decl. ¶ 3.) That settlement agreement provided a mutual release of claims, as well as for Petitioner’s payment of a substantially lesser amount than the amount claimed to be owed under the notes. (Vanecek Decl. Exh. B.) That settlement included recitals as to the “total loan balance” owed by Petitioner under the notes. (Vanecek Decl. Exh. B at p. 1.) The parties agreed to a payment schedule for the discounted settlement amount, but also agreed that in the event of a default, Petitioner would be liable for “principal, interest, through March 11, 2022 plus fees and costs incurred up to that date in collecting [Petitioner’s] obligation under the Notes, including attorneys’ fees,” as well as interest from the date of the settlement’s execution, less amounts paid by Petitioner pursuant to the agreement. (Vanecek Decl. Exh. B, ¶ 6b.) The settlement agreement also included an “affidavit and confession of judgment” executed by Petitioner, in which he stated that as of the date of the settlement’s execution, he owes “the sum of $7,865,991 under the terms of the Notes, including interest through that date and costs and fees, including attorneys’ fees, incurred by Plaintiffs in collecting the amount due.” (Vanecek Decl. Exh. B (Exhibit C to Agreement).)

Petitioner claims not to have defaulted under the settlement agreement, but Respondents in July 2022 returned to arbitration, claiming default in the payments and seeking entry of the substantially higher default award provided for in the settlement agreement. (Souma Decl. ¶ 4; Lewitas Decl. ¶ 3.) The arbitration hearing was held on October 26, 2022. (Lewitas Decl. ¶ 7.) The award was rendered in Respondents’ favor on March 7, 2023, in the amount of $6,390,991.00, representing the amount owed on the date of the settlement agreement’s execution, less payments made by Petitioner through January 2023. (Petition Att. 8(c).)

Petitioner argues that by entering the award according to the default provisions of the settlement agreement, the arbitrators exceeded their powers in violation of Civil Code § 1671. (Motion at p. 15.) Petitioner relies on cases invalidating liquidated damages provisions in settlement agreements that purported to impose larger, original liabilities in the event of a default on a discounted settlement payment. (Motion at pp. 15–16.) These cases include Greentree Financial Group, Inc. v. Execute Sports, Inc. (2008) 163 Cal.App.4th 495, and Purcell v. Schweitzer (2014) 224 Cal.App.4th 969.

In Greentree, the plaintiff sued a defendant for breach of a contract to pay the plaintiff $45,000. (Greentree, supra, 163 Cal.App.4^th at p. 498.) The parties settled, and the defendant agreed to pay a total $20,000, over a two-payment schedule. (Ibid.) But if the defendant defaulted, he agreed to immediately have judgment entered “for all amounts prayed” in the plaintiff’s complaint. (Ibid.) No payments were made, and judgment was entered in the amount of $45,000, plus prejudgment interest, fees, and costs. (Ibid.) On appeal, the court reversed the judgment under Civil Code § 1671, reasoning that the stipulated default judgment operated as a penalty, because the $45,000 judgment did not represent a reasonable estimate of the damages resulting from the defendant’s breach of the settlement agreement: “Greentree argues the amount set forth in the stipulation was reasonably related to the damages it suffered as a result of ESI's breach of the underlying contract. But the breach we are analyzing is the breach of the stipulation, not the breach of the underlying contract.” (Id. at p. 499.) The court reasoned that the judgment ultimately entered against the defendant, in an amount exceeding $60,000, “result[ed] in a penalty assessment of approximately $40,000 more than the total $20,000 due under the stipulation,” and bore “no relationship to any actual damages that might flow from [the defendant]s failure to make the first installment payment.” (Id. at p. 501.) The court further reasoned that the stipulation to settle for a lesser amount contained no admission of liability, and “[t]he lack of a guarantee of success at trial may explain, at least in part, why [the plaintiff] was willing to accept in settlement less than half the amount demanded in the complaint.” (Id. at p. 500.) Thus the court directed the judgment to be reversed and remanded to the trial court with instructions “to reduce the judgment against [the defendant] to $20,000, plus postjudgment interest and costs.” (Id. at p. 503.)

The Purcell case is similar. There, the plaintiff sued the defendant on a defaulted promissory note, seeking to recover the amounts owed. (Purcell, supra, 224 Cal.App.4^th at p. 971.) The parties settled, and the defendant agreed to pay $38,000, with interest, over 24 months. (Id. at p. 972.) The agreement included a provision that if the defendant defaulted, “a judgment for the full amount of ]the defendant]’s original liability of $85,000 could be entered against him.” (Ibid.) The settlement contained an averment that the $85,000 “is an agreed upon amount of monies actually owed, jointly and severally, by the Defendant . . . to the Plaintiff.” (Id. at p.972.) After the defendant defaulted on a payment, judgment was entered against him according to the terms of the settlement, in the amount of $58,839.35. (Id. at p. 973.) The trial court, however, granted a motion brought by the defendant to vacate the default judgment as violative of Civil Code § 1671, which the appellate court affirmed. (Ibid.) The appellate court cited Greentree, reasoning that “the relevant breach to be analyzed “is the breach of the stipulation, not the breach of the underlying contract.” (Id. at p. 975.) The court held, “the stipulation that allowed for entry of judgment in the amount of almost $60,000 was likewise an unenforceable penalty because the underlying settlement was for $38,000. The stipulation bore no reasonable relationship to the damages that it could be expected that [the plaintiff] would suffer as a result of a breach by [the defendant].” (Id. at p. 976.)

Petitioner likens the present case to those above. Whatever Petitioner’s obligations under the original promissory notes, the amount to be paid under the settlement agreement of March 2022 was substantially discounted from the amount actually owed. The provision requiring the entry of judgment in the amount of the actual indebtedness alleged in Respondents’ underlying collection claims operate, Petitioner argues, as impermissible penalties, because they have no relation to the settlement amount or to the damages suffered by Respondents from the late receipt of individual payments under the settlement payment plan. (Motion at pp. 16–21.)

Respondents in opposition present cases with holdings inconsistent with the above authority, specifically Gormley v. Gonzalez (2022) 84 Cal.App.5th 72, 89, and Creditors Adjustment Bureau, Inc. v. Imani (2022) 82 Cal.App.5th 131, 135. (Opposition at pp. 9–11.)

In Gormley, several medical malpractice plaintiffs settled with the defendants for a total payment of $575,000 in two installments, with the proviso that a default would result in the entry of judgment in the amount of $50,000 per month, up to a cap of $1.5 million. (Gormley, supra, 84 Cal.App.5^th at p. 76.) After default, the plaintiffs sought to enter judgment, which the trial court did in the amount of $1.39 million. (Ibid.) When the defendants appealed, arguing that the judgment violated Civil Code § 1671, subd. (b)’s prohibition on liquidated damages provisions that operate as penalties, the appellate court rejected the argument and affirmed the judgment. (Ibid.) The court quoted at length the commentary provided with the revision of section 1671 in 1977, discussing “the circumstances” relevant to a court’s determination of whether a given clause was an unreasonable penalty:

All the circumstances existing at the time of the making of the contract are considered, including the relationship that the damages provided in the contract bear to the range of harm that reasonably could be anticipated at the time of the making of the contract. Other relevant considerations in the determination of whether the amount of liquidated damages is so high or so low as to be unreasonable include, but are not limited to, such matters as the relative equality of the bargaining power of the parties, whether the parties were represented by lawyers at the time the contract was made, the anticipation of the parties that proof of actual damages would be costly or inconvenient, the difficulty of proving causation and foreseeability, and whether the liquidated damages provision is included in a form contract.

The court noted that the only evidence concerning the circumstances of the contract’s formation consisted of the agreement itself and the declaration of the plaintiffs’ counsel, who testified that the plaintiffs had estimated a low potential for genuine recovery against the defendants, given the poor insurance coverage they had, and thus prioritized the prompt payment of a lesser settlement amount, with the penalty provision included to insure prompt payment. (Id. at pp. 85–86.) The defendants were represented by counsel throughout, and several drafts of the settlement agreement were exchanged before agreement was reached.. (Id. at pp. 77–78.)

The court distinguished Greentree, reasoning that its reliance upon the damages from breach of stipulation, rather than the underlying damages in the contract claim, stemmed from the lack of evidence supporting the contention that the Greentree plaintiff could have recovered all amounts assertedly owed at trial. (Id. at p. 87.) By contrast, the amounts for which the Gormley plaintiffs obtained judgment was within the bounds of their trial recovery: “We find nothing unreasonable about parties (particularly represented parties) agreeing to settle a lawsuit for a steep discount, and also agreeing that if the settlement amount is not paid, judgment will be entered on the amount the parties estimated would have been recovered at trial..” (Id. at p. 86.)

The Gormley court cited with approval the decision in Imani, decided two months earlier. (Id. at p. 87.) In Imani, a plaintiff sued a defendant on an unlawful detainer claim, seeking damages of unpaid rent amounting to $257,546.17. (Imani, supra, 82 Cal.App.5^th at p. 134.) The parties settled before trial, and the defendant agreed to pay $30,000.00 in 24 monthly payments, on the condition that if a default occurred, the plaintiff could obtain judgment in the total amount owed. (Id. at p. 134.) A default occurred, and judgment was entered in the amount of $251,200.13. (Id. at p. 134–135.) The appellate court upheld this result against a challenge under Civil Code § 1671, stating, “We cannot isolate the relevant breach of contract as only the breach of settlement agreement or stipulation for entry of judgment and excluding the underlying contract. Here, the $251,200.13 damage provision in the stipulation for entry of judgment is not arbitrarily drawn from thin air. It is the actual and stipulated amount of damages.” (Id. at p. 136.) The court distinguished Greentree, reasoning that the case involved “disputed claims,” while the defendant before them “admitted owing the $251,200.13 as unpaid rent, i.e. damages.” (Id. at p. 137.)

The weight of authority is against Respondents. The primary basis of distinction offered in Gormley and Imani was the undisputed nature of the damages suffered by the plaintiffs seeking the implementation of the judgment, and yet neither court addressed Purcell, which declined to enforce a liquidated damages clause in a settlement agreement for an amount the parties agreed was “actually owed.” (Purcell, supra, 224 Cal. App.4^th at p. 972.) The primary basis for the holdings of these cases was the decision to gauge the section 1671 evaluation, not by the damage to be suffered from a breach of the settlement agreement, but by the damages claimed in the underlying litigation. And yet in this respect, the holdings of Greentree, Purcell, and others are expressly to the contrary: the primary assessment is the relationship between the amount of liquidated damages and the default that activates them, not the damages suffered in the underlying litigation: “[T]he breach we are analyzing is the breach of the stipulation, not the breach of the underlying contract.” (Greentree, supra, 163 Cal.App.4th at p. 499; see also Vitatech Internat., Inc. v. Sporn (2017) 16 Cal.App.5th 796, 809 [same].) Indeed, the continuing primacy of the relationship between the liquidated damages and the reasonably anticipated damages to result from breach was endorsed by the California Supreme Court in Ridgley v. Topa Thrift & Loan Association (1998) 17 Cal.4^th 970, 977:

A liquidated damages clause will generally be considered unreasonable, and hence unenforceable under section 1671(b), if it bears no reasonable relationship to the range of actual damages that the parties could have anticipated would flow from a breach. The amount set as liquidated damages must represent the result of a reasonable endeavor by the parties to estimate a fair average compensation for any loss that may be sustained. In the absence of such relationship, a contractual clause purporting to predetermine damages must be construed as a penalty.

(Ridgley v. Topa Thrift & Loan Ass'n (1998) 17 Cal.4th 970, 977, internal quotation marks and citations omitted.)

Here, there is a large, facial gap between the damages sought to be imposed upon Petitioner and those reasonably anticipated to result from the failure to make timely payments under the settlement plan. Even if the amounts remaining owed under the original promissory notes were undisputed — and Petitioner disputes this, as the settlement agreement disposed not only of Respondents’ initial collection claims but also of Petitioner’s counterclaims (Motion at pp. 9–10; Vanecek Decl. Exh. B) — this would not render the imposition of this amount justified under Civil Code § 1671, because it would constitute the imposition of a penalty for a default in payment under a new and different agreement. The gross disparity in the damages reasonably anticipated to result from late payments, and the liquidated damages that Respondents here seek to impose, warrants the determination that the liquidated damages provision at issue is a penalty under Civil Code § 1671, and therefore unenforceable.

Respondents argue that even if the court is inclined to find that the default judgment amount is unenforceable, the court should instead confirm the arbitration award in the lesser, total amount that the parties agreed to in their settlement. (Motion at p. 7.) However, the authority that Respondents rely upon is inapposite, as the courts in those cases directed that judgments be entered for the full amounts due under the settlement agreement, which had already become owed. (See Red & White Distribution, LLC v. Osteroid Enterprises, LLC (2019) 38 Cal.App.5th 582, 585 [installment payments to be made between December 2014 and December 2015, when case was decided in August 2019].)[1] The payment schedule provided for in the settlement agreement here, however, has not run its course, and not all of the settlement amount has yet come due. (Vanecek Decl. Exh. B.)

Accordingly, Petitioner’s motion to vacate the arbitration award is GRANTED. Respondents’ motion to confirm the award is DENIED.

[1] Respondents’ objection to request for judicial notice submitted by Petitioner in opposition to Respondents’ motion to confirm arbitration award is OVERRULED.