Liquidated Damages versus Penalties

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Liquidated Damages versus Penalties. Planned Pethood Plus, Inc., is a veterinarian-owned clinic. It borrowed $389,000 from KeyBank at an interest rate of 9.3 percent per year for ten years. The loan had a “prepayment penalty” clause that clearly stated that if the loan was repaid early, a specific formula would be used to assess a lump-sum payment to extinguish the obligation. The sooner the loan was paid off, the higher the prepayment penalty. After a year, the veterinarians decided to pay off the loan. KeyBank invoked a prepayment penalty of $40,525.92, which was equal to 10.7 percent of the balance due. The veterinarians sued, contending that the prepayment penalty was unenforceable as a penalty. The bank countered that the amount was not a penalty but liquidated damages and that the sum was reasonable. The trial court agreed with the bank, and the veterinarians appealed. Was the loan’s prepayment charge reasonable, and should it have been enforced? Why or why not?