IN THE

SUPREME COURT OF THE STATE OF ARIZONA

DOBSON BAY CLUB II DD, LLC, A DELAWARE LIMITED LIABILITY COMPANY;

DOBSON BAY CLUB III KD, LLC, A DELAWARE LIMITED LIABILITY COMPANY;

DOBSON BAY CLUB IV KG, LLC, A DELAWARE LIMITED LIABILITY COMPANY;

AND DARBY AZ PORTFOLIO, LLC, A DELAWARE LIMITED LIABILITY

COMPANY,

Plaintiffs/Appellants,

v.

LA SONRISA DE SIENA, LLC, AN ARIZONA LIMITED LIABILITY COMPANY,

Defendant/Appellee.

No. CV-16-0029-PR

Filed April 25, 2017

Appeal from the Superior Court in Maricopa County

The Honorable John Christian Rea, Judge

No. CV2013-000989

REVERSED AND REMANDED

Opinion of the Court of Appeals, Division One

239 Ariz. 132, 366 P.3d 1022 (App. 2016)

VACATED

COUNSEL:

Brian J. Pollock (argued), Jared L. Sutton, Lewis Roca Rothgerber Christie 

LLP, Phoenix, Attorneys for Dobson Bay Club II DD, LLC, et al. 

Michael A. Schern, Mark A. Hanson, Schern Richardson Finter Decker PLC, 

Mesa; and Stephen C. Biggs (argued), Smith LC, Phoenix, Attorneys for La 

Sonrisa de Siena, LLC

D. Jeffrey Craven, The Craven Firm PLLC, Phoenix, Attorneys for Amicus 

Curiae Arizona Private Lender Association
DOBSON BAY, ET AL. V. LA SONRISA DE SIENA LLC

Opinion of the Court

2

JUSTICE TIMMER authored the opinion of the Court, in which CHIEF 

JUSTICE BALES, VICE CHIEF JUSTICE PELANDER, and JUSTICE

BRUTINEL joined. JUSTICE BOLICK dissented.

JUSTICE TIMMER, opinion of the Court:

¶1 A liquidated damages contract provision is enforceable if the 

pre-determined amount for damages seeks to compensate the nonbreaching party rather than penalize the breaching party. We here hold 

that a nearly $1.4 million late fee assessed on a final loan balloon payment 

constitutes an unenforceable penalty.

I. Background

¶2 In 2006, Canadian Imperial Bank of Commerce loaned 

Dobson Bay Club II DD, LLC and related entities (“Dobson Bay”) $28.6 

million for Dobson Bay’s purchase of four commercial properties. The loan

was secured by a deed of trust encumbering those properties. Under the 

terms of a promissory note, Dobson Bay was to tender interest-only 

payments to Canadian Imperial Bank until the loan matured in September 

2009, when the entire principal would become due—the “balloon” 

payment. In 2009, the parties extended the loan maturity date to September 

2012.

¶3 Dobson Bay bore significant consequences for any delay in 

payment. In addition to continuing to pay regular interest, Dobson Bay was 

required to pay default interest and collection costs, including reasonable 

attorney fees, and a 5% late fee assessed on the payment amount. If 

Canadian Imperial Bank foreclosed the deed of trust, Dobson Bay was also

obligated to pay costs, trustee’s fees, and reasonable attorney fees.

¶4 As the 2012 loan maturity date approached, the parties 

negotiated to extend that date but could not reach an agreement. The 

maturity date passed, and Dobson Bay failed to make the balloon payment.

¶5 La Sonrisa de Siena, LLC (“La Sonrisa”) bought the note and 

deed of trust from Canadian Imperial Bank and promptly noticed a 

trustee’s sale of the secured properties. It contended that Dobson Bay owed

more than $30 million, including a nearly $1.4 million late fee. Dobson Bay 
DOBSON BAY, ET AL. V. LA SONRISA DE SIENA LLC

Opinion of the Court

3

disputed it owed various sums, including the late fee. Litigation ensued. 

Dobson Bay secured new financing and paid the outstanding principal and 

undisputed interest in March 2013. (Dobson Bay simultaneously deposited 

the disputed amounts with the superior court pending the litigation.) The 

parties filed cross-motions for partial summary judgment on whether the 

late fee provision in the note was an enforceable liquidated damages 

provision or, instead, an unenforceable penalty.

¶6 The superior court granted partial summary judgment for La 

Sonrisa, ruling that the late fee was enforceable as liquidated damages. The 

court of appeals reversed, holding “as a matter of law, that absent unusual 

circumstances the imposition of a flat 5% late-fee on a balloon payment for 

a conventional, fixed-interest rate loan is not enforceable as liquidated 

damages.” Dobson Bay Club II DD, LLC v. La Sonrisa de Siena, LLC, 239 Ariz. 

132, 140 ¶ 22, 366 P.3d 1022, 1030 (App. 2016).

¶7 We granted review because the enforceability of late fee 

provisions in commercial loan agreements presents a legal issue of 

statewide importance. We have jurisdiction pursuant to article 6, section 

5(3) of the Arizona Constitution and A.R.S. § 12-120.24.

II. Discussion

A. Enforceability of liquidated damages provisions

¶8 Parties to a contract can agree in advance to the amount of 

damages for any breach. See Miller Cattle Co. v. Mattice, 38 Ariz. 180, 190, 

298 P. 640, 643 (1931). Such “liquidated damages” provisions serve 

valuable purposes. They provide certainty when actual damages would be 

difficult to calculate, and they alleviate the need for potentially expensive

litigation. Cf. Mech. Air Eng’g Co. v. Totem Constr. Co., 166 Ariz. 191, 193, 801 

P.2d 426, 428 (App. 1989) (noting that a liquidated damages provision 

“promotes enterprise by increasing certainty and by decreasing riskexposure, proof problems, and litigation costs); Restatement (Second) of 

Contracts (“Restatement Second”) § 356 cmt. a. (Am. Law Inst. 1981) (“The 

enforcement of such provisions . . . saves the time of courts, juries, parties 

and witnesses and reduces the expense of litigation.”).
DOBSON BAY, ET AL. V. LA SONRISA DE SIENA LLC

Opinion of the Court

4

¶9 Parties, however, do not have free rein in setting liquidated 

damages. Because “[t]he central objective behind the system of contract 

remedies is compensatory, not punitive,” parties cannot provide a penalty 

for a breach. Restatement Second § 356 cmt. a; see also id. (“Punishment of 

a promisor for having broken his promise has no justification on either 

economic or other grounds and a term providing such a penalty is

unenforceable on grounds of public policy.”). “A [contract] term fixing 

unreasonably large liquidated damages is unenforceable on grounds of 

public policy as a penalty.” Id. § 356(1). The contract remains valid, 

however, and the non-breaching party can still recover actual damages. See 

Gary Outdoor Advert. Co. v. Sun Lodge, Inc., 133 Ariz. 240, 243, 650 P.2d 1222, 

1225 (1982); Miller Cattle, 38 Ariz. at 190, 298 P. at 643.

¶10 Arizona courts have used different methods to decide 

whether stipulated damages provisions are enforceable as liquidated 

damages or void as penalties. This Court has considered whether the 

stipulated amounts were reasonably related to actual damages. See 

Marshall v. Patzman, 81 Ariz. 367, 370, 306 P.2d 287, 289 (1957); Tennent v. 

Leary, 81 Ariz. 243, 249, 304 P.2d 384, 388 (1956); Weatherford v. Adams, 31 

Ariz. 187, 197, 251 P. 453, 456 (1926); Armstrong v. Irwin, 26 Ariz. 1, 9, 221 P.

222, 225 (1923). We have also examined liquidated damages provisions

prospectively, considering whether they were reasonable at the time the 

contracts were created. See Gary Outdoor Advert. Co., 133 Ariz. at 242–43, 

650 P.2d at 1224–25; Miller Cattle, 38 Ariz. at 190, 298 P. at 643.

¶11 Our court of appeals has generally applied a two-part test 

developed under the Restatement (First) of Contracts (“Restatement First”)

(Am. Law Inst. 1928) § 339. Under that test, which our dissenting colleague 

implicitly relies on, see infra ¶ 50, a stipulated damages provision is an 

unenforceable penalty unless “(1) the amount fixed is a reasonable forecast 

of just compensation for harm that is caused by the breach, and (2) the harm 

caused is ‘incapable or very difficult of accurate estimation.’” Dobson Bay 

Club, 239 Ariz. at 136 ¶ 9, 366 P.3d at 1026 (citing Restatement First § 339); 

see also Pima Sav. & Loan Ass’n v. Rampello, 168 Ariz. 297, 300, 812 P.2d 1115, 

1118 (App. 1991); Mech. Air Eng’g Co., 166 Ariz. at 193, 801 P.2d at 428;

Larson-Hegstrom & Assocs., Inc. v. Jeffries, 145 Ariz. 329, 333, 701 P.2d 587, 591 

(App. 1985).
DOBSON BAY, ET AL. V. LA SONRISA DE SIENA LLC

Opinion of the Court

5

¶12 In this case, the court of appeals applied Restatement Second

§ 356(1), which reframed the Restatement First test in 1981 to harmonize 

with Uniform Commercial Code (“UCC”) § 2-718(1). See Dobson Bay Club,

239 Ariz. at 136 ¶ 9 n.2, 366 P.3d at 1026 n.2; Restatement Second § 356 

reporter’s note. Section 356(1) provides that a liquidated damages 

provision is enforceable, “but only at an amount that is reasonable in the 

light of the anticipated or actual loss caused by the breach and the 

difficulties of proof of loss.” This test requires courts to consider (1) the 

anticipated or actual loss caused by the breach, and (2) the difficulty of 

proof of loss. Whether a fixed amount is a penalty turns on the relative 

strengths of these factors. As explained by comment b to § 356:

If the difficulty of proof of loss is great, 

considerable latitude is allowed in the 

approximation of anticipated or actual harm. If, 

on the other hand, the difficulty of proof of loss 

is slight, less latitude is allowed in that 

approximation. If, to take an extreme case, it is 

clear that no loss at all has occurred, a provision 

fixing a substantial sum as damages is 

unenforceable.

¶13 La Sonrisa urges us to disavow the Restatement Second § 

356(1) test to the extent it “retrospectively” considers actual damages. It

contends that this approach undermines the contracting parties’ freedom to 

allocate risk and defeats the purpose of a liquidated damages provision by 

requiring the non-breaching party to establish actual damages. Not so.

¶14 Section 356(1) provides two methods for deciding whether 

the parties’ damages forecast was reasonable. The amount is reasonable if 

it approximates either the loss anticipated at the time of contract creation 

(despite any actual loss) or the loss that actually resulted (despite what the 

parties might have anticipated in other circumstances). See Restatement

Second § 356 cmt. b. The non-breaching party is not required to prove 

actual damages to enforce a liquidated damages provision, and a court will 

respect the parties’ agreement if it is “reasonable” in relation to anticipated 

or actual loss. But if the difficulty of proof of loss is slight and either no loss 

occurs or the stipulated sum is grossly disproportionate to the loss, the 

parties’ stipulation would be unreasonable and therefore unenforceable as 
DOBSON BAY, ET AL. V. LA SONRISA DE SIENA LLC

Opinion of the Court

6

a penalty. See id. This approach is consistent with this Court’s opinions.

See Marshall, 81 Ariz. at 370, 306 P.2d at 289 (holding that stipulated 

damages were “unconscionable under the circumstances” and 

unenforceable because the non-breaching party suffered no loss); 

Weatherford, 31 Ariz. at 197, 251 P. at 456 (“Where the amount retained is 

grossly disproportionate to the actual damages . . . and, especially, when 

there is available a simple method for ascertaining the exact damages, [a 

stipulated damages provision] will be considered as a penalty.”).

¶15 We adopt the Restatement Second § 356(1) to test the

enforceability of a stipulated damages provision. First, § 356(1) aligns with 

UCC § 2-718(1), which Arizona has adopted. See A.R.S. § 47-2718(A). Thus, 

courts can apply the same test to both UCC-governed and non-UCCgoverned contracts. Second, the test best accommodates the goal of 

compensating the non-breaching party for a loss rather than penalizing the 

breaching party. Under the Restatement Second test, courts have flexibility 

to respect the parties’ right to stipulate to damages for a breach but, when 

appropriate, prevent imposition of a penalty.

B. Application of Restatement Second § 356(1) to this case

¶16 The late fee provision in the promissory note here provides: 

If any installment payable under this 

Note (including the final installment due on the 

Maturity Date) is not received by Lender prior 

to the calendar day after the same is due . . . 

Borrower shall pay to Lender upon demand an 

amount equal to the lesser of (a) five percent 

(5%) of such unpaid sum or (b) the maximum 

amount permitted by applicable law to defray 

the expenses incurred by Lender in handling 

and processing such delinquent payment and to 

compensate Lender for the loss of the use of 

such delinquent payment . . . .

La Sonrisa seeks 5% of the late balloon payment; “the maximum amount 

permitted by applicable law” is not at issue.
DOBSON BAY, ET AL. V. LA SONRISA DE SIENA LLC

Opinion of the Court

7

¶17 Dobson Bay, as the party seeking to avoid enforcement of the 

late fee provision, has the burden of persuading this Court that the 

provision imposes an unenforceable penalty. Cf. United Behavioral Health v. 

Maricopa Integrated Health Sys., 240 Ariz. 118, 122 ¶ 14, 377 P.3d 315, 319 

(2016) (stating that the party claiming that a contractual arbitration 

provision is preempted by federal law bears the burden of proving it); Goode 

v. Powers, 97 Ariz. 75, 81, 397 P.2d 56, 60 (1964) (noting that a challenger to 

a contract bears the burden of showing illegality); Duenas v. Life Care Ctrs.

of Am., Inc., 236 Ariz. 130, 136 ¶ 14, 336 P.3d 763, 769 (App. 2014) 

(concluding that party challenging a contract term bears the burden of 

showing unconscionability); see also DJ Mfg. Corp. v. United States, 86 F.3d 

1130, 1134 (Fed. Cir. 1996) (“A party challenging a liquidated damages 

clause bears the burden of proving the clause unenforceable.”). To decide 

the matter, we do not apply any bright-line rules but construe the clause 

“according to the circumstances of the case, and in the light of all the facts 

surrounding it.” Miller Cattle, 38 Ariz. at 190, 298 P. at 643.

¶18 We review the grant of partial summary judgment de novo as 

an issue of law. See Cramer v. Starr, 240 Ariz. 4, 7 ¶ 8, 375 P.3d 69, 72 (2016).

Whether a contract provides for liquidated damages or a penalty is also an 

issue of law we review de novo. See Rampello, 168 Ariz. at 300, 812 P.2d at

1118.

1. Anticipated or actual damages

¶19 Dobson Bay argues that the late fee provision was neither a 

reasonable forecast of anticipated damages nor reasonably related to actual 

damages incurred as a result of the untimely balloon payment because La 

Sonrisa’s loss has been compensated already by payment of default interest 

and collection costs. La Sonrisa asserts that actual damages are irrelevant. 

It contends that when the loan was made, the 5% late fee was a reasonable 

forecast of just compensation for harm that could be caused by Dobson 

Bay’s default in timely making the balloon payment.

a. Anticipated damages

¶20 The late fee did not reasonably forecast anticipated damages 

likely to result from an untimely balloon payment.
DOBSON BAY, ET AL. V. LA SONRISA DE SIENA LLC

Opinion of the Court

8

¶21 First, the 5% fee is static, payable on demand whether the 

payment is one day late or one year late. Five percent of the loan principal 

is a significant sum of money, which did not likely reflect losses from a short 

delay in payment. Because the fee did not account for the length of time 

Canadian Imperial Bank would be deprived of the balloon payment, the fee 

could not reasonably predict the Bank’s loss. Cf. Miller Cattle, 38 Ariz. at 

190, 298 P. at 643 (stating that a principal rule used to decide whether a 

contract imposes a penalty or liquidated damages is whether the payment 

“is a fixed and definite sum, regardless of the nature or extent of the breach 

of the contract, or whether it is based upon, and varies with, the nature and 

extent of the breach”); Grand Union Laundry Co. v. Carney, 153 P. 5, 7 (Wash. 

1915) (cited with approval in Miller Cattle, 38 Ariz. at 190, 298 P. at 643) 

(“[A]nother feature that some times influences courts to construe a 

provision for liquidated damages into a penalty [is that] of fixing for any 

one of several different kinds and degrees of breach an equal forfeiture of 

money.”).

¶22 La Sonrisa asserts that the 5% late fee did not necessarily 

establish a fixed sum of approximately $1.4 million as “[a]t the time the 

parties formed their agreement, the exact amount of the final installment 

was unknown because the loan documents provided Dobson Bay with the 

flexibility to pay all, some, or none of the principal prior to the maturity 

date.” But the note permits Dobson Bay to prepay the loan principal only 

“in whole” and “not in part,” except that any condemnation or casualty 

insurance proceeds would be applied to pay down the principal. Thus, 

unless Dobson Bay prepaid the entire principal amount, meaning the late

fee provision would not apply, the parties contemplated that the balloon 

payment would approximate the entire loan principal, requiring a late fee 

of roughly $1.4 million for an untimely payment.

¶23 Second, the late fee either duplicated other fees triggered by a 

default or was grossly disproportionate to any remaining sums needed to 

compensate for the anticipated losses identified in the late fee provision. Cf. 

United Dairymen of Ariz. v. Schugg, 212 Ariz. 133, 138 ¶ 16, 128 P.3d 756, 761 

(App. 2006) (“The right to recover liquidated damages is limited by the 

express terms of the parties’ agreement.”); 11 Joseph M. Perillo, Corbin on 

Contracts § 58.11 at 457 (rev. ed. 2005) (“The probable injury that the parties 

had reason to foresee is a fact that largely determines the question whether 

they made a genuine pre-estimate of that injury . . . .”).
DOBSON BAY, ET AL. V. LA SONRISA DE SIENA LLC

Opinion of the Court

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¶24 The late fee is calculated as the lesser of 5% of the delinquent 

payment or the maximum amount permitted by law “to defray the 

expenses incurred by [Canadian Imperial Bank] in handling and processing 

such delinquent payment and to compensate [Canadian Imperial Bank] for 

the loss of the use of such delinquent payment.” It is debatable whether 

this quoted language qualifies each calculation method or just the latter one. 

But it matters not. Requiring an “either-or” comparison to fix the late fee 

suggests that both calculation methods were intended to compensate for 

the same categories of loss: (1) the costs in handling and processing a late 

payment, and (2) the loss of use of the payment. Cf. Smith v. Melson, Inc., 

135 Ariz. 119, 121, 659 P.2d 1264, 1266 (1983) (“A contract should be read in 

light of the parties’ intentions as reflected by their language and in view of 

all the circumstances.”); State ex rel. Goddard v. R.J. Reynolds Tobacco Co., 206 

Ariz. 117, 122 ¶¶ 23–24, 75 P.3d 1075, 1080 (App. 2003) (stating that words 

used in a contract must be read in context); see also In re Mkt. Ctr. E. Retail 

Prop., Inc., 433 B.R. 335, 344, 363 (Bankr. D.N.M. 2010) (interpreting almost 

identical language as stating the purpose for the late fee).

¶25 Both categories of loss identified in the late fee provision are 

substantially addressed elsewhere in the promissory note and deed of trust. 

Assuming that “handling and processing” includes actions taken to collect 

the late payment, those costs would be compensated by Dobson Bay’s 

required payment of “all costs of collection,” including reasonable attorney 

fees, and, in the event of foreclosure, “all expenses incident to such 

proceeding,” including attorney fees and trustee’s fees and costs. The loss 

of use of money would be compensated by continuing payments of regular 

interest plus default interest. Cf. Ariz. E. R.R. Co. v. Head, 26 Ariz. 259, 262,

224 P. 1057, 1058 (1924) (“Interest is the compensation paid for the use of 

money.”).

¶26 What’s left to compensate by payment of a $1.4 million late 

fee? La Sonrisa and the dissent rely on an affidavit from Mitchel 

Medigovich, a commercial lending expert, who opined that a 5% late fee is 

a reasonable forecast of just compensation for impairment of a bank’s 

economic interests due to an untimely balloon payment. But much of this 

anticipated impairment falls outside the two categories of loss identified by 

the parties in the late fee provision. For example, Medigovich states that a 

predetermined late fee compensates for post-default “reputational risks,” 

“regulatory risks,” and the “risk of expense of preserving the collateral.”
DOBSON BAY, ET AL. V. LA SONRISA DE SIENA LLC

Opinion of the Court

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Medigovich addresses the categories of loss identified in the late fee 

provision by stating that late fees properly subsidize a lender’s debt 

collection practices and compensate for the loss of expected funds. He does 

not explain, however, what amounts, if any, are reasonably needed to 

compensate for these expected losses when, as here, the borrower is already 

obligated to pay all collection costs and interest at both the regular rate and 

a default rate. Consequently, Medigovich’s affidavit does not persuade us 

that a flat $1.4 million late fee was a reasonable forecast of Canadian 

Imperial Bank’s anticipated losses from a late balloon payment that would 

not have been compensated by the payment of regular interest, default 

interest, and collection costs.

¶27 This case is distinguishable from MetLife Capital Financial 

Corp. v. Washington Avenue Associates L.P., 732 A.2d 493 (N.J. 1999), on which

La Sonrisa and the dissent rely. There, the court concluded that a 5% late 

charge assessed against delinquent monthly installment payments of about 

$14,000 was enforceable as liquidated damages. Id. at 495–96, 502. The 

reasonableness of applying the charge against a final balloon payment was 

not at issue. See id. at 495 (“We now consider whether the five percent late 

charge assessed against each delinquent payment . . . constitute[s] 

reasonable stipulated damages provisions.”); see also MetLife Capital 

Financial Corp. v. Washington Ave. Assoc., L.P., 713 A.2d 527, 531 (N.J. App. 

1998) (stating that application of the late charge against a final balloon 

payment of about $69,000 was not at issue), aff’d in part, rev’d in part, 732 

A.2d 493 (N.J. 1999). Assessing a $700 late fee for an untimely installment 

payment may well reflect a reasonable assessment of the internal costs of 

monitoring and collecting late installment payments during the loan 

tenure. But that is a far cry from assessing a nearly $1.4 million fee for a 

delayed balloon payment of the loan principal, particularly given that the 

lender here was otherwise entitled to compensation for its collections costs 

and loss of use of the funds.

¶28 In sum, a flat 5% late fee did not reasonably predict the 

damages that would be sustained by Canadian Imperial Bank for a late 

balloon payment of the entire loan principal.

b. Actual damages
DOBSON BAY, ET AL. V. LA SONRISA DE SIENA LLC

Opinion of the Court

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¶29 The $1.4 million late fee did not reasonably approximate 

either the actual costs of handling and processing the late balloon payment 

or the loss of use of that payment.

¶30 The summary judgment papers did not address the actual 

losses incurred by Canadian Imperial Bank and La Sonrisa after Dobson 

Bay’s default. Nevertheless, the record reflects that neither lender spent 

significant time handling and processing the late payment. The only

outstanding payment was the last payment, and nothing suggests that 

either lender had much to “handle and process” before the trustee’s sale 

was initiated. Cf. In re Mkt. Ctr. E. Retail Prop., Inc., 433 B.R. at 364 

(concluding that after default on a balloon payment “there would be little 

or no more administrative expenses in handling and processing delinquent 

payments” and “[a]ll that is left to do is have the attorneys sue to 

foreclose”). The note already required Dobson Bay to pay any collection 

costs, including attorney fees. It is inconceivable that any remaining 

administrative collection costs approached $1.4 million, particularly in light 

of the short time between the default and initiation of the trustee’s sale—

about three months. Thereafter, the deed of trust applied to require Dobson 

Bay to pay attorney fees and trustee’s fees and costs.

¶31 La Sonrisa was also compensated for the loss of use of money 

suffered by it and its assignor, Canadian Imperial Bank, by Dobson Bay’s 

obligation to pay regular and default interest. Cf. K.B. v. State Farm Fire &

Cas. Co., 189 Ariz. 263, 267, 941 P.2d 1288, 1292 (App. 1997) (“An assignee 

steps into the shoes of her assignor.”). Dobson Bay was current on the loan 

until the maturity date. La Sonrisa did not dispute Dobson Bay’s 

representation at oral argument before this Court that La Sonrisa received 

between $600,000 and $700,000 in default interest alone for the six-month 

delay in paying the balloon amount.

¶32 In sum, nothing indicates that either lender, separately or 

together, suffered an uncompensated loss that approached $1.4 million.

2. Difficulty of proof of loss

¶33 We next consider the difficulty of proving the losses actually 

sustained by Canadian Imperial Bank and La Sonrisa in handling and 

processing the late balloon payment and by being deprived of use of that 
DOBSON BAY, ET AL. V. LA SONRISA DE SIENA LLC

Opinion of the Court

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payment. Restatement Second § 356 cmt. b & illus. 2–4. In doing so, we 

examine the difficulty of either proving that a loss occurred or establishing 

its amount with certainty. Id. § 356 cmt. b.

¶34 La Sonrisa would have had no difficulty proving it sustained 

a loss in handling and processing the late balloon payment, if a loss

occurred. (Because La Sonrisa noticed the trustee’s sale about a week after 

acquiring the loan, it may not have expended any resources handling and 

processing the balloon payment.) It could have produced evidence of the 

tasks undertaken by it to do so. La Sonrisa would have had slightly more

difficulty precisely proving the amount of damages incurred from any such 

loss depending on what activities constituted “handling and processing” 

and how it allocated the costs of these activities. Cf. Garrett v. Coast & S. Fed. 

Sav. & Loan Ass’n, 511 P.2d 1197, 1203 (Cal. 1973) (invalidating a late fee 

provision and noting that “[t]he lender’s charges could be fairly measured 

by the period of time the money was wrongfully withheld plus the 

administrative costs reasonably related to collecting and accounting for a 

late payment”).

¶35 La Sonrisa would have had no difficulty proving that either 

lender sustained a loss by being deprived of the use of the balloon payment. 

Interest on the outstanding amount could have been assessed to 

compensate for the loss of use of money. Cf. Ariz. E. R.R. Co., 26 Ariz. at 

262, 224 P. at 1058. And La Sonrisa would be entitled to collect interest 

earned when Canadian Imperial Bank was the note payee and the loan was 

in default. Cf. K.B., 189 Ariz. at 267, 941 P.2d at 1292. Indeed, the 

promissory note required Dobson Bay to pay regular interest and default 

interest for that purpose.

¶36 In sum, under the circumstances here, the difficulty of 

proving La Sonrisa’s loss as identified in the late fee provision was slight.

3. Consideration of factors

¶37 We are persuaded that the late fee is an unenforceable 

penalty. The difficulty of proving losses attributable to handling and 

processing the balloon payment was slight. We therefore give less latitude 

to Canadian Imperial Bank and Dobson Bay’s approximation of anticipated 

or actual harm. See Restatement Second § 356 cmt. b.
DOBSON BAY, ET AL. V. LA SONRISA DE SIENA LLC

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¶38 As explained, the late fee neither reasonably forecasted

anticipated damages for the losses identified in the late fee provision nor 

reasonably approximated the actual losses. In view of Dobson Bay’s 

obligation to pay regular and default interest, collection costs, trustee’s fees 

and costs, and attorney fees as a consequence of the six-month delay in 

paying the balloon, an approximate $1.4 million late fee is unreasonable and 

an unenforceable penalty. La Sonrisa is not precluded, however, from 

seeking actual damages incurred for handling and processing the late 

balloon payment and for losing use of the payment if La Sonrisa has not 

already been compensated for that loss by the other fees and costs Dobson 

Bay is required to pay under the note and deed of trust. See Gary Outdoor 

Advert. Co., 133 Ariz. at 243, 650 P.2d at 1225.

C. The dissent

¶39 Our dissenting colleague colorfully compares our decision to 

a child’s cry of “backsies” to sidestep a promise. Rather than invoking 

playground rules, however, we apply long-established common law 

principles that render contractual penalty provisions—even when agreed 

upon by sophisticated parties—unenforceable as a matter of public policy. 

This is nothing unique. Courts will likewise disregard the parties’ intent 

and refuse to enforce contract terms that are unconscionable, illegal, or 

otherwise against public policy. Cf. Maxwell v. Fidelity Fin. Servs., Inc., 184 

Ariz. 82, 88, 907 P.2d 51, 57 (1995) (“[E]ven if the contract provisions are 

consistent with the reasonable expectations of the party they are 

unenforceable if they are oppressive or unconscionable.” (internal 

quotations and alterations omitted)); Goodman v. Newzona Inv. Co., 101 Ariz. 

470, 474, 421 P.2d 318, 322 (1966) (recognizing “the fundamental right of the 

individual to [have] complete freedom to contract . . . so long as his contract 

is not illegal or against public policy”). That the dissent prefers to ignore 

these principles does not affect their applicability.

¶40 The dissent is also incorrect that our decision runs afoul of the 

Arizona Constitution’s “contract clause,” article 2, § 25, an argument La 

Sonrisa has never made. Our colleague contends that we assign Dobson 

Bay a burden of persuasion that is so insubstantial it “impair[s] the 

obligation of contract.” See infra ¶ 46. But judicial invalidation of a contract 

provision does not implicate the contract clause. Cf. Tidal Oil Co. v. 

Flanagan, 263 U.S. 444, 451 (1924) (finding no violation of the federal 
DOBSON BAY, ET AL. V. LA SONRISA DE SIENA LLC

Opinion of the Court

14

contract clause where a state supreme court declared a contract void and 

unenforceable because “the obligation of contracts against state action[] is 

directed only against impairment by legislation and not by judgments of 

courts”); Barrows v. Jackson, 346 U.S. 249, 260 (1953) (citing Tidal and holding 

that a state court’s refusal to enforce a racially restrictive covenant did not 

violate the federal contract clause); see also Fields v. Elected Officials’ Ret. Plan, 

234 Ariz. 214, 218 ¶ 16, 320 P.3d 1160, 1164 (2014) (noting that the Court 

interprets Arizona’s contract clause using an “analysis similar to that 

employed by the Supreme Court” when interpreting the federal contract 

clause); Hall v. Elected Officials’ Ret. Plan, 241 Ariz. 33, 383 P.3d 1107, 1126 ¶ 

69 (2016) (Bolick J., dissenting in part and concurring in the judgment in 

part) (noting, with regard to the state contract clause, that “[h]istorically, 

Arizona courts have applied the United States Supreme Court’s test for 

determining violations of the Contract Clause of the Federal Constitution”).

¶41 Even if the contract clause had been argued here and applies, 

it would not change our decision. The contract clause only limits the state’s 

ability to impair existing contract obligations; it does not curtail application 

of proscriptive principles that existed at the time of contract creation. Cf. 

State v. Direct Sellers Ass’n, 108 Ariz. 165, 169–70, 494 P.2d 361, 365–66 (1972) 

(“The [contract clause of the federal constitution] means only that no state 

may impair the obligation of an [e]xisting contract.”); Foltz v. Noon, 16 Ariz. 

410, 417, 146 P. 510, 512 (1915) (noting that a statute will not violate the 

Arizona Contract Clause “when applied to contracts made subsequent to 

its taking effect”); Samaritan Health Sys. v. Superior Court, 194 Ariz. 284, 293 

¶ 41, 981 P.2d 584, 593 (App. 1998) (“[Arizona’s] contract impairment clause 

only limits the legislature’s ability to impair obligations under existing 

contracts.”). Our cases proscribed penalty clauses long before origination 

of the loan here, and the note incorporated this proscription. Cf. Bhd. of Am. 

Yeomen v. Manz, 23 Ariz. 610, 615, 206 P. 403, 404 (1922) (“It is a familiar rule 

that the law in force at the time a contract is executed enters into and forms 

a part of the contract.”); Qwest Corp. v. City of Chandler, 222 Ariz. 474, 484 ¶ 

34, 217 P.3d 424, 434 (App. 2009) (“[A]ll contracts incorporate applicable 

statutes and common-law principles.”). Consequently, our refusal to 

enforce a penalty provision did not impair the parties’ contract obligations 

here.

III. Conclusion
DOBSON BAY, ET AL. V. LA SONRISA DE SIENA LLC

Opinion of the Court

15

¶42 We vacate the court of appeals’ opinion, reverse the trial 

court’s partial summary judgment in favor of La Sonrisa on the liquidated 

damages claim, and remand to that court for further proceedings, including 

entry of partial summary judgment for Dobson Bay on its declaratory relief 

claim concerning the late fee. We award Dobson Bay its reasonable attorney 

fees pursuant to A.R.S. § 12-341.01 subject to its compliance with ARCAP

21(c).
DOBSON BAY, ET AL. V. LA SONRISA DE SIENA LLC

JUSTICE BOLICK, Dissenting 

16

BOLICK, J., dissenting.

¶43 As children, we learn that the rules of the playground dictate 

that if someone makes a promise, no matter how solemnly, it is 

unenforceable if the person making the promise had his fingers crossed 

behind his back. As we grow up, we learn instead that many promises are 

moral and legal obligations, with consequences properly attached to 

breaking them. Still, some grown-ups prefer the playground rules.

¶44 The Court today invalidates a core and unambiguous 

provision of a contract freely negotiated for mutual benefit between 

sophisticated parties represented by competent counsel. After Dobson Bay 

reaped the full benefits of its bargain, it defaulted on its repayment 

obligation and looked to the courts to avoid significant agreed-upon 

consequences of that default. The majority determines that the liquidated 

damages provision agreed to by the parties is an unenforceable penalty, 

based on its thorough examination of the Restatement (Second) of 

Contracts. Because I believe that over the course of that journey the 

majority lost the forest for the trees, I respectfully dissent.

¶45 The relevant provision of the Restatement (Second) is 

consistent with A.R.S. § 47-2718, which provides that a contract term “fixing 

unreasonably large liquidated damages is void as a penalty.” As with all 

statutes, we must construe this provision, if at all possible, in a 

constitutional manner. State v. Thompson, 204 Ariz. 471, 474 ¶ 10, 65 P.3d 

420, 423 (2003). 

¶46 Freedom of contract allows individuals to order their affairs 

and exchange goods and services, without coercion, in accord with their 

personal values and priorities. The Arizona Constitution so venerates 

contractual freedom that it is enshrined in our Declaration of Rights. Article 

2, section 25 commands, “No . . . law impairing the obligation of a contract, 

shall ever be enacted.” That provision requires us to indulge every 

presumption in favor of upholding a contract negotiated as this one was, 

and to assign a substantial burden of demonstrating unenforceability to the 

party challenging the terms to which it willingly and knowingly agreed. 

The majority purports to assign the burden of persuasion to Dobson Bay,

see ¶ 17, but that “burden” is so insubstantial as to transform § 47-2718 into 

“a law impairing the obligation of a contract.”

¶47 “The law of liquidated damages is unique within the common 

law of contracts because it overtly affronts freedom of contract.” Larry A. 
DOBSON BAY, ET AL. V. LA SONRISA DE SIENA LLC

JUSTICE BOLICK, Dissenting 

17

Dimatteo, A Theory of Efficient Penalty: Eliminating the Law of Liquidated 

Damages, 38 Am. Bus. L.J. 633, 634 (2001). That is because it allows courts 

to displace the intent of the parties by determining that a provision amounts 

to a penalty. Such discretion should be exercised with great care, for as the 

majority aptly notes, liquidated damages provisions “serve important 

purposes,” such as providing certainty when actual damages would be 

difficult to calculate and avoiding the costs and delays of litigation. See ¶ 8.

¶48 Moreover, “a party concerned foremost with performance, 

especially a timely performance, may use such a clause in the hope that it 

will provide a further inducement for performance.” Dimatteo, 38 Am. Bus. 

L.J. at 634. Certainly that is the case with the contract here. Dobson Bay 

sought a considerable loan—$28.6 million—to purchase four commercial 

properties. Under the contract terms, it would make interest-only 

payments for a prescribed period, after which it would repay the entire 

principal in a “balloon” payment. The timely return of the principal is a 

critical, indeed defining, feature of the loan. The contract underscored that 

fact by requiring, in addition to other fees described by the majority, a 5% 

fee for late interest payments or principal repayment. Absent evidence to 

the contrary by the party properly bearing the burden of proof, we may 

presume that the substantial loan Dobson Bay sought would not have been 

made absent this assurance.

¶49 The lender was not voracious. Before the balloon payment 

was originally due in 2009, the parties negotiated a three-year extension. 

As the new date approached, the parties negotiated over another extension 

but failed to reach agreement. Thereafter the note was sold to La Sonrisa 

which then commenced foreclosure proceedings.

¶50 The majority applies two factors in determining whether the 

liquidated damages provision is “reasonable”: the anticipated or actual loss 

caused by the breach, and the difficulty of proof of loss. See ¶ 12. Proving 

the provision is reasonable based on actual damages makes little sense in 

most instances, given that the point of a liquidated damages provision is to 

avoid litigation that requires proving actual damages. Accordingly, the 

proper inquiry “is whether the stipulated amount was, when all of the facts 

are considered, reasonable at the time of the contract and not whether it was 

reasonable with the benefit of hindsight.” Rampello, 168 Ariz. at 300, 812 

P.2d at 1118. At the same time, citing a comment to Restatement (Second) 

§ 356, the majority notes that if the difficulty of forecasting actual damages 

is great, considerable latitude is appropriate in assigning liquidated 

damages. Although the difficulty of forecasting the amount of loss here 
DOBSON BAY, ET AL. V. LA SONRISA DE SIENA LLC

JUSTICE BOLICK, Dissenting 

18

was great, the majority extends no such latitude.

¶51 The majority concludes that the lender is compensated for 

losses owing to a dilatory final payment elsewhere in the contract; 

specifically, through collection costs and foreclosure expenses. See ¶ 25. 

Further, “[t]he loss of use of money would be compensated by continuing 

payments of regular interest plus default interest.” Id. Given that we have 

no idea the use to which the lender would have put the money had it been 

returned in a timely manner, that conclusion is conjecture, and illustrates 

precisely why liquidated damages provisions are preferable to protracted 

litigation and judicial second-guessing.

¶52 The main cost to the lender of failing to recover the loan 

corpus in a timely fashion, and the most difficult to calculate in advance, is 

opportunity cost. La Sonrisa produced a declaration from Mitchel 

Medigovich, who has extensive experience as an Arizona trustee and real 

estate broker and originator. He attests that when a borrower unilaterally 

extends the due date of a balloon payment, it imposes costs, including 

opportunity costs, upon the lender. He likens the situation to a car rental 

company with a fixed fleet of cars. If a renter unilaterally extends a rental 

even by one day, it diminishes fleet availability and the ability to provide 

new rentals, which has economic ripple effects throughout the enterprise.

¶53 Medigovich summarized the consequences of a late final 

payment and the purpose of a liquidated damages provision:

Many lenders including banks make projections for expected 

and scheduled repayment of loans with which the lender 

makes interest payments to depositors, new loan 

commitments to prospective borrowers, bond payments to 

investors or to replenish capital reserves. In any event, failure 

of the borrower to make any scheduled payment including a 

payment due upon maturity of the loan, particularly in the 

case of [a] large commercial loan such as in this case puts the 

lender at great risk of default of its own commitments . . . . 

Consequently, in most commercial transactions, the parties 

agree that if the Borrower fails to make a final payment of 

principal on the due date, (a unilateral extension), the 

economic impact to the Lender is incalculable and therefore a 

Late Fee is necessary as liquidated damages to the lender.

¶54 Such late fees are not a penalty because (1) “[a] lender with a 
DOBSON BAY, ET AL. V. LA SONRISA DE SIENA LLC

JUSTICE BOLICK, Dissenting 

19

non-performing loan has significantly increased risk of recovery,” (2), “in 

addition to the expense of managing the non-performing asset, the lender is 

denied the ability to reinvest expected . . . payments into new performing 

investments at current market rates” (emphasis added), and (3) “the lender 

may be at risk of defaulting on other loan commitments wherein funding is 

contemplated by the loan maturing.” Whether any or all of those factors 

will occur in a particular loan context is unpredictable, and the cost of 

possible lost opportunities is inherently difficult to calculate.

¶55 Consequently, Medigovich observes, customary late fees for 

commercial transactions typically start at 4% or 5% and range up to 10%. 

In Medigovich’s view, the 5% fee here was “perhaps below what is 

reasonable for the circumstances,” which involved “a complex transaction 

with multiple properties as the collateral and multiple entities as the 

Borrower.”1

¶56 Thus, even though La Sonrisa did not bear the burden of 

proving that the liquidated damages provision was reasonable, it supplied 

powerful evidence that the economic damages flowing from default or 

delayed final payment were potentially substantial, difficult to forecast or 

calculate, and not fully encompassed by other fees in the contract.

¶57 In contrast, Dobson Bay, the party that purportedly bore the 

burden of proof, presented by way of contravening evidence: absolutely 

 1 Here, the lender sold the note to La Sonrisa. Amicus Arizona Private 

Lender Association explains the circumstances that give rise to such a sale:

These lenders often have a significant portion of 

their total available funds invested at any given 

time. . . . Therefore, it is important to private 

lenders that their borrower repay on time to free 

up cash for new loans to keep the money 

moving and working for the business. . . . Thus 

when a borrower defaults on the repayment of 

the principal, the lender may be forced to sell 

the note to a collection agency at a discount. 

Late fees and default interest make the 

defaulted notes more attractive to collection 

firms, resulting in higher purchase prices for the 

notes, which helps the lender to protect against 

losses and keep its capital in the market.
DOBSON BAY, ET AL. V. LA SONRISA DE SIENA LLC

JUSTICE BOLICK, Dissenting 

20

nothing.2

¶58 Unsurprisingly, the trial court, which weighed the evidence 

presented by La Sonrisa and the absence thereof by Dobson Bay, concluded 

that the liquidated damages provision was enforceable. The court of 

appeals, by contrast, held that as a matter of law, “absent unusual 

circumstances,” a 5% liquidated damages provision in a contract like this is 

unenforceable. Dobson Bay, 239 Ariz. at 140 ¶ 22, 366 P.3d at 1030. The court 

cited neither law nor precedent for such a sweeping substantive 

pronouncement, although at least it provided a clear rule to which 

contracting parties could conform themselves.

¶59 The majority’s opinion here is more legally grounded but also 

far more nebulous. Is a default fee based on a percentage amount per se 

invalid because it does not vary with the duration of the default, even 

though amount-based late fees may not fully compensate for lost 

opportunity costs; or do the parties have to litigate every time to find out, 

which defeats the important purposes of liquidated damages clauses? 

Either way, the economic consequences may be severe. As La Sonrisa’s 

expert attested, again unrebutted by the party ostensibly bearing the 

burden of proof, percentage-based liquidated damages provisions for late 

balloon payments are common components of commercial loan contracts. 

Every single one is now in legal purgatory.

¶60 I prefer the approach taken by the New Jersey Supreme Court 

in MetLife, 732 A.2d at 499, which is more faithful to the Restatement and 

protective of freedom of contract. MetLife involved a contract containing 

percentage-based late and default fees as liquidated damages, in addition 

to collection and various other fees. Id. at 495–96. At trial, MetLife’s expert 

testified that a 5% late fee was the industry custom and standard, and was 

a reasonable forecast of costs including “lost investment opportunities.” Id.

at 496. Unlike here, the party challenging the provision actually produced 

contrary evidence. Id. at 497. The trial court found both the late fee and a 

12.55% default fee represented reasonable liquidated damages. Id. The 

 2 “Under a traditional common law analysis, the burden of proof regarding 

the enforceability of a liquidated damages clause rests squarely on the party 

seeking to set it aside.” Dimatteo, 38 Am. Bus. L.J. at 664–65. “Although 

courts recognize this traditional allocation of burden of proof, in reality the 

onus seems to be upon the non-breaching party to prove 

reasonableness. . . . In fact, some courts remain largely influenced by any 

disproportion between the stipulated amount and actual damages.” Id. at 

667–68. That is an accurate depiction of the majority analysis.
DOBSON BAY, ET AL. V. LA SONRISA DE SIENA LLC

JUSTICE BOLICK, Dissenting 

21

court of appeals reversed for reasons similar to those in the majority 

opinion here. Id. at 497–98.

¶61 The Supreme Court reversed the court of appeals. It began by 

noting that a “need for close scrutiny arises from the possibility that 

stipulated damages clauses may constitute an oppressive penalty.” Id. at 

498. But the court should assess such provisions on a “continuum; the more 

uncertain the damages caused by a breach, the more latitude courts give the 

parties on their estimate of damages.” Id. The court held that “liquidated 

damages provisions in a commercial contract between sophisticated parties 

are presumptively reasonable and the party challenging the clause bears 

the burden of proving its unreasonableness.” Id. at 499.

¶62 Applying those standards, the court concluded that the 5% 

late fee was reasonable because (1) “[i]t seems evident that late payments 

on larger loans would present a greater risk to the lender” given that they 

constitute a larger portion of a lender’s portfolio, and (2) “damages 

resulting from the loss of investment opportunity increases with the size of 

the late installment payment,” thus “a lender suffers both larger 

administrative and ‘opportunity cost’ damages when a borrower is late 

with a larger payment.” Id. at 500. Because operational “costs are spread 

over an entire loan portfolio, it is difficult to identify specific damages 

attributable to the late payment or default of one specific borrower.” Id.

¶63 Given the difficulty in forecasting damages from late 

payment or default, the court looked to what was permitted by statute “and 

what constitutes common practice in a competitive industry.” Id. The 

testimony that 5% was the industry standard was (as here) uncontradicted. 

Id. By contrast, cases in which fixed-percentage liquidated damages 

provisions were struck down “involved unusually large percentages or 

explicit evidence of a coercive intent.” Id. at 501–02 (citing cases). 

¶64 The court also sustained the 12.55% default interest rate. “As 

with the costs of late payments, the actual losses resulting from a 

commercial loan default are difficult to ascertain.” Id. at 503. “The lender 

cannot predict the nature or duration of a possible default,” nor “is it 

possible when the loan is made to know what market conditions might be” 

at time of default or “what might be recovered from a sale of the collateral.” 

Id. “For example, a lender cannot know what its own borrowing costs will 

be if a borrower defaults . . . nor accurately predict what economic return it 

will lose when the borrower fails to repay the loan on time.” Id. Because 

the 12.55% default interest rate “appears to be a reasonable estimate of 
DOBSON BAY, ET AL. V. LA SONRISA DE SIENA LLC

JUSTICE BOLICK, Dissenting 

22

potential damages, falls well within the range demonstrated to be 

customary, and because a stipulated damages clause negotiated between 

sophisticated commercial entities is presumptively reasonable,” the court 

sustained it. Id.

¶65 Our Court likewise should presume that a liquidated 

damages provision negotiated by sophisticated parties is valid and 

conclude that the party bearing the burden of demonstrating its 

unreasonableness failed to sustain that burden in this case. Instead, we 

reward the party breaching the contract by removing a critical term to 

which it assented and, as a necessary consequence adding both insult and 

injury, require the non-breaching party to pay its attorney fees. Our 

decision will inevitably have a corrosive effect on the making and 

enforcement of contracts in Arizona, with predictable and substantial 

adverse economic consequences, notwithstanding that freedom of contract 

is enshrined in our organic law. With great respect to my colleagues, I 

dissent.