Late-Fee Litigation and Legislation

If you have been attending tradeshows and state-association meetings, and have been reading any industry-related publications, you would probably agree the issue of late fees is one of the hottest and most important topics in self-storage today. This month's article focuses on the history and recent developments in this important area.

The Legal Principal

A late fee is a "liquidated damages" clause in your rental agreement. In simple terms, a liquidated-damages clause in any contract presumes there is a possibility that one of the involved parties might breach the contract, and fixes the amount that will be awarded to one party in this event. A liquidated-damages provision is enforceable only if the anticipated or actual loss caused by the breach will be difficult to ascertain at the time it occurs, and is not so large as to constitute a penalty.

In the self-storage application, the rental agreement anticipates the possibility the occupant will not pay rent on time. It is, therefore, appropriate to set a fixed amount of damages the parties agree the occupant will pay if he is late with rent. This is necessary because it would be difficult, if not impossible, to calculate the exact amount in damages an operator suffers as a result of any one occupant's delinquency. The difficulty lies in the fact that, in any given month, the number, amount and length of delinquencies will vary. Since damage from late rent is incalculable, a late fee is appropriate in rental agreements. However, the fee may not be so large as to "act as a penalty." In other words, it must represent a fair approximation of actual damages suffered as a result of the late payment.

How the Trouble Started

While the issue of late fees had been on the minds of some state attorney generals, it came to the forefront in the summer of 1997 in the case of Louis Birch et al. v. United Cable Television of Baltimore. The case involved an attorney, Mr. Birch, who was charged a $5 late fee by United. He felt a $5 late fee on a $20 cable bill that was only paid a few days late was a penalty and, therefore, not a valid liquidated-damages provision. When Birch called to argue the $5 charge with the cable company, the "well-trained" operator suggested she could disconnect Birch's service if he did not like their policies and fee structure. Birch then sued on behalf of himself and the other 112,000 cable subscribers who may have paid a late fee during the prior three years.

The short conclusion to this story is that in June 1999, the Maryland Court of Appeals affirmed a judgment in the amount of $6,701,503.60, representing the $4.50 difference between the late fee amount of $5 and the actual damages suffered by United Cable of 50 cents per late payment. The court also awarded pre-judgment interest and attorneys fees because it concluded a $5 late fee on a $20-per-month bill constituted a penalty and, thus, was a punitive liquidated-damages provision.

After Birch won his case, he began suing other public utilities, such as his telephone company and the electric company, for their high late fees. He then began packaging and selling his ideas about class-action lawsuits for high late fees to other attorneys, who would bring the actions against other utilities locally. Two months after the Birch decision was affirmed by the Maryland Court of Appeals, David Grinnell sued Public Storage for its late fees in the Circuit Court for Baltimore City, Md. The attention of self-storage owners, associations and attorneys was then focused on the issue of self-storage late fees.

The Public Storage case has not reached a resolution as of press time. However, if there is a big verdict or settlement in favor of the occupants, this will surely initiate another stream of class-action lawsuits in other states where there is not a statute protecting owners. In the meantime, a Texas trial court recently dismissed a class-action late-fee suit. The late fee was $12.50 on a $300-per-month unit, and the plaintiffs alleged this was an unreasonably high late fee. In this case, a dismissal is a victory as a precedent has been set. That does not, however, mean the attorneys in Texas are not looking for another, more dramatic late-fee case to file.

Definition of a Late Fee

It is important to remember what a late fee is--and is not. A late fee is a charge assessed by an operator for an occupant's failure to pay rent when due. It should accurately reflect an approximation of the damages an operator actually suffers as a result of the late payment. A late fee cannot be designed to act as punishment. How do we calculate our late fee?

An operator may include in his calculation of the late fee the loss he incurs as a result of the late payment. Of course, what makes it so difficult to calculate is that you do not know whether the tenant is going to pay late by one day, week, month or longer. An operator can make a reasonable approximation and calculate the lost value by either a) the state's legal interest rate or b) the actual out-of-pocket costs to the operator, such as late fees on mortgages or other bills that were unable to be paid as a result of the occupant's failure to pay rent.

The operator can also include in his calculations the work performed to ensure the tenant has not vacated the space, such as a physical inspection of the unit, the time the manager spends attempting to collect rent, and any reminder letters/postage. All these charges must be divided by the average number of delinquencies in each month. As you can see, even if you were to charge a portion of the time your manager devotes to these activities every month and divide by the number of delinquencies, the actual dollar figure is low.

You should not include "actual costs" in your calculation, for example, the cost of sending certified notices, placing lien-sale advertisements, running lien searches through local or state recorders offices, the cost of cutting locks or performing an auction, or sale expenses. That being said, how do you know if your late fee accurately reflects costs and expenses but is not deemed a penalty? Some states have recently solved this problem (not necessarily to the operator's advantage) by enacting statutes that provide the appropriate late fee in a self-storage situation. Where this isn't the case, operators should maintain strict guidelines for actions taken in the event of late payment so they can demonstrate the expenses incurred as necessary and justifiable.

Legislative Update

The best way to avoid late-fee litigation is if your state enacts a law setting the fee that can be legally charged. Hopefully, it will also include a safe-harbor provision protecting operators from any litigation inspired by late fees in compliance with the law as well as any charged prior to its passage.

Before you become too excited by this proposition, the experience thus far in self-storage late-fee legislation has not been completely positive. As of press time, only three states have statutes that clearly set forth the appropriate late fee for self-storage. The first is North Carolina, where the late fee may not exceed 15 percent of the rent due. This is certainly easy to understand, but probably difficult for software to calculate based on different rates of rent for different size spaces. The next state with a statute is Arizona, which allows a $5 late fee on a balance of less than $25, and a fee of either $10 or 5 percent on a balance of $25 or more. The Arizona law is not as clear in its application to self-storage, but you should comply with this formula until a court determines it is not applicable to this industry. Finally, California put a statute into effect Jan. 1. The California law states if a balance due is less than $60, you may not charge more than a $10 late fee. If the balance is $60 to $100, you may not charge more than a $15 late fee, and if the balance is greater than $100, you may charge $20 or 15 percent of the balance due, whichever is greater.

Maryland also has a statute regarding late fees; however, I cannot state with any certainty that the Maryland legislation applies to self-storage because the law refers to the industries that provide consumer services. One could certainly argue the rental of a self-storage unit may not be a consumer service. Nevertheless, until there is greater certainty as to the applicability of this act, owners in Maryland ought to factor these guidelines into their calculations.

According to the statute, the late fee is limited to the greater of $5 or 10 percent of the monthly rental payment, and no more than three late fees may be charged; the late fee must be disclosed in the rental agreement in at least 10-point bold-face type; and the late fee may not be imposed until 15 days after the payment is due. That being said, the law provides for an exception if the entity to whom you are renting is a business tenant. Again, implementation in your computer system can be the most difficult part of following this act.

The closest thing to a pro-owner late-fee bill for self-storage was proposed and narrowly failed to pass in Missouri. I expect the act will be reintroduced this year and hopefully pass, at which time it will act as an example to other states. The proposed Missouri act called for $20 or 20 percent of the monthly rental amount, whichever was greater, for each late rental payment. The act specifically defines this amount as reasonable and not a penalty. It further provides that an operator can set a higher late fee if it is reasonable to do so, with the operator having the burden of proof.

In concordance with the Self Storage Association and other industry professionals, I encourage you to get involved with your state associations, which are pushing to introduce and pass legislation similar to the SSA model act (the proposed Missouri act). The best way to know you are safe is to have a piece of legislation that provides guidance on late fees and a safe harbor for owners.

Litigation Update

Most punitive late-fee cases do not specifically apply to self-storage, so we can't gain a lot of insight from their results. We see late charges for cable television and apartment rents being litigated, but the court rulings are generally inconsistent. For example, in Alabama in 1993, the Supreme Court ruled that a late fee equal to one-third of a month's rent was an illegal penalty. However, in 1997, an Indiana Court of Appeals held that a late fee equaling 30 percent of the monthly rent was reasonable.

Courts have also held that prompt payment, on-time payment discounts or "street rent" (where rent is reduced to a certain amount as long as it is paid by a certain date) is simply an attempt to disguise a late fee. The courts are treating those arrangements as liquidated-damages clauses and applying the same standards to determine whether those arrangements are punitive and, therefore, unenforceable.

Conclusion

Louisiana came close to having the worst of all possible late-fee bills passed against its owners. One of the reasons a harsh late-fee bill was proposed was because a state legislator failed to pay rent for several months and was hit with tremendous fees, some of which were proper late fees, others of which did not appear to have been properly itemized. Nevertheless, the legislator/tenant clearly intended to "strike back" at the industry.

It is important operators clearly itemize charges in their rental agreements and, when notifying tenants of charges they have incurred, that they clearly distinguish between late fees and other charges, such as those incurred as a result of enforcing your lien. It is important that operators work with their state associations to pass legislation to protect themselves when it comes to late-fee charges; but in the meantime, operators should be extremely cautious. A conservative late fee may pay great dividends later in the avoidance of expensive class-action litigation.

As always, I look forward to any comments you may have involving this subject or others you would like to see addressed in this column.

Jeffrey Greenberger practices with the law firm of Katz, Greenberger & Norton LLP in Cincinnati, which represents owners and operators of commercial real estate, including self-storage. Mr. Greenberger, licensed to practice law in Ohio and Kentucky, is the legal counsel for the Ohio Self Storage Owners Society and the Kentucky Self Storage Association, as well as a regular presenter at Inside Self-Storage Expos. Questions, comments or suggestions for future topics can be sent to Jeffrey Greenberger c/o Katz, Greenberger & Norton LLP, 105 E. Fourth St., Suite 400, Cincinnati, OH 45202; call 513.721.5151; e-mail [email protected].