Traditional Contract Law “Penalty” Clause Analysis Does Not Apply to Matrimonial Settlement Agreements

Holtham v. Lucas, 460 N.J. Super. 308 (App. Div. 2019). As Judge Ostrer noted in the first sentence of his opinion in this case today, “[a]ccording to well-settled contract law, a provision that stipulates an unreasonably large amount of damages for a future breach is an unenforceable penalty.” The parties to this matrimonial case entered into a marital settlement agreement that contained a “per diem penalty of $150” for any breach of any duty under that agreement. When plaintiff failed to timely pay off a loan on a car that was to be distributed to his (ex-)wife and to tender title to the vehicle to her, he challenged the per diem provision, asserting that it was an invalid penalty.

The Family Part enforced the provision. Plaintiff appealed, won a battle, but lost the war, as the Appellate Division, applying de novo review of the purely legal question at issue, affirmed the ruling against him.

Judge Ostrer reviewed at length the law governing penalty clauses, and what distinguishes them from liquidated damage provisions. That very useful discussion led him to conclude that, in a traditional contract case, the provision here would be considered as an unenforceable penalty.

But the panel went on to hold that this aspect of traditional contract law does not apply to marital settlement agreements. Though such an agreement is “no less a contract” than an agreement to settle a commercial dispute, “for equitable reasons normal tenets of contract interpretation are sometimes not applicable to matrimonial matters.”

Quoting a law review article, Judge Ostrer observed that the normal penalty rule “deprives a non-breaching party of adequate compensation for ‘idiosyncratic value,’ such as sentimental attachment, as opposed to ‘objective market valuation.'” In the matrimonial context, “post-divorce peace” is a highly-valued thing that is not covered by traditional penalty principles.

Judge Ostrer went on to note that “[t]he penalty rule also does not account for the fact that parties to matrimonial agreements may behave far differently than the rational economic actors presumed to participate in typical contractual relationships.” For example, he said, parties may take actions simply to harm the other party, whether such actions are economically efficient or rational, or not.

Finally, the fact that Court Rules allow monetary sanctions for violations of matrimonial settlement agreements “reflect a public policy that is receptive to penalty clauses designed to achieve the same end.” That policy, along with the policy of enforcing divorcing parties’ own choice of contractual provisions, led Judge Ostrer to conclude that the penalty rule is inapplicable in the marital settlement agreement context. In reaching that conclusion, the panel found persuasive decisions from other states that had reached that same result, acknowledging, however, that other jurisdictions, whose rulings were deemed unpersuasive, had come out the other way.

Judge Ostrer ended by suggesting that Family Part judges “scrutinize a penalty provision in light of the totality of circumstances.” He cited a number of circumstances to be considered. The Family Part, Judge Ostrer said, has broad authority “to reform a penalty provision to achieve fairness and equity.”

Here, the totality of the circumstances, including plaintiff’s sophistication and great wealth, and the fact that he was represented by counsel and thus knew what the penalty clause meant, pointed toward enforcing that provision. The panel thus affirmed the decision of the Family Part.