By Anthony Geraci, Esq. | Founder, Geraci LLP Published: October 2022 | Updated: January 2025
Default interest provisions represent one of the most important economic protections available to private lenders. The ability to charge elevated interest rates when borrowers breach payment obligations serves two essential purposes: compensating lenders for increased risk and collection costs, and creating powerful incentive for borrowers to cure defaults promptly rather than allowing loans to languish in non-performing status.
California private lenders operate within a complex legal framework governing when, how, and under what circumstances default interest may be charged. Recent litigation has challenged traditional practices, creating uncertainty about default interest enforceability and forcing lenders to reevaluate their loan documentation and collection strategies.
This comprehensive guide examines the California default interest landscape as it exists in 2025, including historical legal frameworks, key court decisions that have shaped current practice, and practical strategies for structuring enforceable default interest provisions.
Default Interest Fundamentals: Economic Purpose and Legal Structure
Before examining the complex California legal framework, understanding default interest fundamentals provides essential context.
What Default Interest Accomplishes
Default interest serves multiple economic and behavioral purposes in private lending:
Common Default Interest Structures
Private lenders employ several approaches to default interest pricing:
A 10% base rate would increase to 15% upon default under this structure. The increase applies automatically without requiring lender notice or action, though prudent lenders typically notify borrowers of default interest application.
- Payment defaults: +2% default interest
- Material covenant defaults (property waste, unauthorized transfers): +3% default interest
- Maturity defaults: +5% default interest
This tiered approach matches default interest increases to default severity and associated lender risks.
Default Interest vs. Late Charges: Critical Distinctions
Understanding the difference between default interest and late charges is essential:
- Apply only to specific overdue installment payments
- Typically calculated as percentage of missed payment (5% is common) or fixed fee ($50-$100)
- Constitute one-time charges per missed payment
- Generally enforceable in California if reasonably related to lender’s default costs
- Clearly characterized as “late charges” or “delinquency charges” in loan documents
- Applies to entire outstanding principal balance once default occurs
- Calculated as interest rate increase (e.g., from 10% to 15%) on full loan amount
- Accrues continuously until default is cured
- Enforceability in California has been subject to legal challenge (discussed extensively below)
- Characterized as interest rate increases or “default rate” provisions
This distinction matters enormously because California courts have applied different legal analyses to late charges versus default interest, with late charges facing fewer enforceability challenges.
Historical California Default Interest Framework: Garrett v. Coast and Its Progeny
For decades, California courts applied a relatively clear framework for default interest enforceability established primarily through the Garrett v. Coast & Southern Federal Savings & Loan Association case decided in 1973 by the California Supreme Court.
The Garrett Decision and Its Traditional Interpretation
Garrett involved a consumer loan secured by residential real estate. The borrower defaulted on payment obligations, and the lender sought to charge increased interest on the full principal balance pursuant to a default interest provision in the loan documents.
The California Supreme Court held that lenders could charge default interest on the principal balance only when borrowers breached the maturity date of the loan—meaning, failed to pay the entire balance when due at loan maturity. The Court reasoned that until maturity, borrowers have no obligation to pay principal (in the context of interest-only or amortizing loans with balloon payments), so imposing elevated interest rates on principal they’re not yet required to pay constitutes an improper penalty.
However, the Court held that lenders could properly charge:
1. Late charges on missed installment payments, provided the charges reasonably approximate lender’s default-related costs 2. Default interest on past-due installments that borrowers failed to pay when due 3. Default interest on the full principal balance upon maturity defaults (failure to pay the loan in full when due)
This framework provided workable guidance for decades. Private lenders structured default interest provisions consistent with Garrett: applying late charges to missed installments, charging elevated interest rates only on past-due amounts, and reserving default interest on full principal balances for maturity defaults.
Industry Practice Under Traditional Garrett Framework
Based on Garrett and subsequent cases applying its reasoning, California private lenders adopted several documentation practices:
This approach worked reasonably well for commercial and business-purpose lenders, as Garrett involved consumer loans and several subsequent court decisions suggested the reasoning might not apply fully to commercial lending contexts.
The Honchariw v. FJM Decision: Disrupting Decades of Practice
In September 2022, the California First District Court of Appeal issued a decision in Honchariw v. FJM Private Mortgage Fund that sent shockwaves through the California private lending community. The decision appeared to dramatically expand Garrett‘s holding in ways that threatened standard default interest practices.
Factual Background of Honchariw
The case involved a business-purpose loan from FJM Private Mortgage Fund (a California-based private lender) to Robert Honchariw (an attorney who has been involved in numerous lender disputes over the years) secured by real estate. The borrower defaulted on payment obligations before the loan’s maturity date.
Pursuant to the loan documents’ default interest provision, FJM charged default interest on the full outstanding principal balance. The borrower disputed this practice, arguing that under Garrett, default interest could apply only to past-due installments, not the entire principal balance, until a maturity default occurred.
The dispute went to arbitration (as required by the loan documents), where the arbitrator ruled in favor of FJM, finding the default interest charges proper. Honchariw appealed to the California Superior Court, which affirmed the arbitration award. Honchariw then appealed to the First District Court of Appeal.
The Court of Appeal’s Holding
The First District Court of Appeal reversed, holding that Garrett prohibited charging default interest on the principal balance for any default other than maturity default—including payment defaults, covenant defaults, or any other default category.
Key aspects of the Court’s reasoning:
No Default Interest on Principal Until Maturity: According to the Court, lenders may only charge default interest on the entire principal balance when borrowers fail to pay the full balance at the stated maturity date. Payment defaults, covenant breaches, or other default events don’t justify charging default interest on principal.
Immediate Industry Impact
The Honchariw decision created immediate confusion and concern throughout California private lending:
Geraci LLP’s Response and Subsequent Legal Developments
Immediately following the Honchariw decision, our firm was retained to represent FJM in seeking reversal of the decision through available appellate remedies.
Petition for Rehearing and Depublication
California’s appellate process allows parties adversely affected by Court of Appeal decisions to seek rehearing (asking the same court to reconsider) or depublication (requesting the California Supreme Court to prevent the decision from being published and thus limiting its precedential effect).
Our firm filed a comprehensive Petition for Rehearing with the First District Court of Appeal, arguing that the Court had misinterpreted Garrett and created unworkable rules for California lending. We contended that:
1. Garrett Was Distinguishable: The Garrett decision involved specific facts (consumer loan, residential property, different loan structure) that didn’t translate directly to all private lending contexts.
2. Commercial Lending Should Apply Different Standards: Business-purpose loans to sophisticated borrowers warrant different treatment than consumer loans to individual homeowners.
3. Economic Realities: The decision ignored economic realities of private lending, where default interest on principal balances serves legitimate risk compensation and payment incentive purposes.
4. Conflict with Industry Practice: Decades of lending practice and documentation had proceeded under a different understanding of Garrett‘s limitations.
California Supreme Court Consideration
Following denial of rehearing by the Court of Appeal, we petitioned the California Supreme Court to grant review—essentially asking the state’s highest court to accept the case, review the Court of Appeal’s decision, and issue definitive guidance on default interest enforceability.
The petition argued that the Honchariw decision created substantial practical problems for the lending industry and conflicted with reasonable interpretations of prior precedent. We urged the Supreme Court to accept review and either reverse the Honchariw decision or provide clearer guidance for California lenders.
Current Status as of January 2025
As of this article’s publication in January 2025, the California Supreme Court has not granted review of Honchariw, and the decision remains published precedent from the First District Court of Appeal. This means:
Practical Implications for California Private Lenders in 2025
Given the current legal landscape, California private lenders must navigate default interest issues carefully, balancing risk mitigation against economic realities.
Documentation Strategies
Lenders can implement several strategies in loan documentation to address Honchariw concerns:
The safest approach involves structuring default interest provisions consistent with the Honchariw interpretation:
- Limit default interest on principal balance to maturity defaults only
- Charge robust late fees on missed installments (5-10% of payment amounts, if legally permissible)
- Apply default interest to past-due installments
- Include explicit maturity default language triggering default interest on full principal balance
Many lenders operating outside the First District continue using traditional default interest provisions that charge elevated rates on full principal balances for any default, acknowledging the risk of Honchariw-based challenges:
- Include standard default interest provisions applying to principal balance for all defaults
- Price default interest risk into loan economics
- Prepare to negotiate default interest challenges if they arise
- Consider whether borrower sophistication, loan size, and collateral coverage justify taking the risk
This approach works best for lenders whose portfolios are concentrated outside Northern California and who have strong bargaining leverage with borrowers.
Some lenders structure documents to convert payment defaults into maturity defaults through acceleration:
“Upon the occurrence of any Event of Default, Lender may, at its sole option, declare the entire outstanding Principal Balance, all accrued interest, and all other sums payable under this Note immediately due and payable. Upon such acceleration, the Maturity Date shall be deemed to have occurred, and all provisions applicable to Maturity Defaults, including the Default Interest Rate on the entire Principal Balance, shall immediately apply.”
This approach attempts to work within Honchariw‘s framework by creating maturity defaults (which clearly allow default interest on principal) through acceleration upon payment defaults. However, its effectiveness remains untested, and some argue it circumvents the policy concerns underlying Honchariw.
Regardless of default interest structure, lenders should maintain robust late charge provisions that operate independently:
- Charge substantial late fees (5-10%) on each missed payment
- Apply default interest to past-due installments (which Honchariw explicitly permits)
- Include default interest on principal only for maturity defaults
- Ensure late charges are characterized as “late charges” or “delinquency fees” not “interest”
This creates meaningful economic consequences for defaults even without principal-based default interest before maturity.
Geographic Risk Assessment
Lenders should assess default interest risk based on collateral location and likely dispute venue:
Collection and Default Management Strategies
When defaults occur, lenders should consider Honchariw implications:
Transparent Default Interest Communication: When charging default interest, provide borrowers with clear calculation explanations. If challenged, be prepared to defend the charges or negotiate reductions.
The Broader California Default Interest Debate: Policy Considerations
Beyond the technical legal analysis, the Honchariw decision raises policy questions about default interest roles in private lending.
Arguments Supporting Restrictive Default Interest Rules
Those who support Honchariw and restrictive default interest enforcement argue:
Arguments Opposing Restrictive Default Interest Rules
Conversely, many within the private lending industry argue Honchariw creates unworkable limitations:
Best Practices for Navigating California Default Interest Landscape
Given the current uncertainty, California private lenders should implement several best practices:
1. Comprehensive Legal Review
Have experienced lending counsel review your loan documents’ default interest provisions specifically for Honchariw compliance. This review should assess:
- Current default interest language and its enforceability under Honchariw
- Whether conservative revisions are appropriate given your geographic lending focus
- Late charge provision adequacy as alternative economic leverage
- Acceleration provision interplay with default interest triggers
- Overall document consistency between promissory notes, deeds of trust, and loan agreements
2. Borrower Sophistication Analysis
Consider borrower sophistication when evaluating default interest risk:
- Experienced real estate investors with legal counsel: Lower risk of Honchariw-based challenges, as sophisticated borrowers understood and accepted default interest provisions
- First-time borrowers without counsel: Higher risk of challenges, particularly if defaults lead to significant default interest charges
- Borrowers with history of lender disputes: Expect aggressive challenges to any questionable provisions
3. Geographic Portfolio Strategy
Analyze your lending portfolio by geographic concentration:
- Heavy First District exposure: Consider conservative default interest documentation or price Honchariw risk into loan economics
- Diversified California exposure: Maintain awareness of Honchariw but may continue traditional practices with appropriate risk reserves
- Out-of-state focus: Honchariw is largely irrelevant, though be aware of each state’s specific default interest rules
4. Default Interest Monitoring and Adjustment
Monitor default interest legal developments and be prepared to adjust:
- Track California Supreme Court docket for potential Honchariw review
- Monitor other Court of Appeal decisions addressing default interest
- Watch for legislative proposals addressing default interest rules
- Maintain relationships with industry associations and legal counsel who monitor developments
5. Dispute Resolution Provisions
Consider arbitration or other dispute resolution mechanisms:
- Mandatory arbitration clauses may provide more favorable forums for default interest disputes than courts bound by Honchariw
- Arbitrators focus on contract terms and commercial reasonableness rather than strict precedent
- Include prevailing party attorney fee provisions to discourage frivolous challenges
6. Transparent Borrower Communication
Reduce default interest disputes through clear borrower communication:
- Provide borrowers with plain-language explanations of how default interest works
- Include examples in loan documents showing default interest calculations
- When defaults occur, immediately notify borrowers about default interest implications
- Demonstrate willingness to work with borrowers on cure strategies to minimize default interest accumulation
Conclusion: Navigating Uncertainty with Prudent Risk Management
The California default interest landscape remains in flux following Honchariw, creating ongoing uncertainty for private lenders. While the decision hasn’t been adopted uniformly across California and may yet be subject to Supreme Court review or legislative revision, it represents binding precedent in Northern California and influences disputes statewide.
Lenders operating in California must make strategic decisions about default interest structuring, balancing conservative compliance approaches against economic realities and competitive positioning. There’s no one-size-fits-all solution—appropriate strategies depend on geographic lending focus, borrower sophistication, portfolio composition, and risk tolerance.
What’s clear is that lenders can no longer rely on decades-old assumptions about default interest enforceability without careful legal analysis. Default interest provisions require thoughtful drafting, clear borrower communication, and prepared responsiveness to legal challenges when they arise.
Our firm continues to actively monitor California default interest developments, counsel clients on documentation strategies, and represent lenders in disputes involving default interest challenges. We remain committed to advocating for sensible default interest rules that balance legitimate borrower protection against lenders’ reasonable need for economic leverage in default situations.
For guidance on structuring default interest provisions for California lending, reviewing existing loan documents for Honchariw compliance, or defending against default interest challenges, contact Geraci LLP’s Banking and Finance team. Our attorneys provide practical solutions navigating California’s complex default interest landscape while protecting your legitimate lending interests.
About the Author: Anthony Geraci is the founder of Geraci LLP, a law firm specializing in private lending, fund formation, and securities compliance for the real estate finance industry. Anthony has counseled California private lenders for over 15 years and has particular expertise in default interest issues, having represented FJM Private Mortgage Fund in appellate proceedings following the Honchariw decision.
Geraci LLP provides comprehensive legal services for private lenders including loan documentation preparation, default interest provision analysis, compliance counseling, and litigation defense when borrowers challenge lending practices. The firm serves clients nationwide from offices in California and Arizona.
