The Massachusetts Appeals Court recently struck down a liquidated damages provision in a commercial lease. In so doing, the Court followed well-established precedent in declining to enforce a liquidated damages provisions that is considered a penalty. The outcome highlights the importance of careful consideration of potential damages when entering into contracts.
To step back briefly – liquidated damages are a stipulated contract sum that parties agree to in advance as a reasonable estimate of potential damages for a breach. Parties utilizing these provisions forgo the opportunity to determine actual damages after a breach in exchange for the certainty and peace of mind provided by a liquidated damages clause. If a party breaches a contract, the beneficiary of the provision is entitled to the stipulated amount and is not required to prove actual damages or to attempt to mitigate them. These provisions simplify the measure of contract damages when actual damages are hard to predict at the time of contracting; however, to be enforceable, liquidated damages must be a reasonable estimate of damages expected to occur in the event of a breach. A contractual provision that operates as a penalty is unenforceable.
In Mittas Early Learning, LLC v. MDC Properties – Westford Rd., LLC, et al., a dispute arose between a commercial landlord (MDC) and its tenant (Mittas) concerning development of a childcare center in Tyngsboro, Massachusetts. The original parties to the contract, a developer and franchisor, assigned their lease rights to MDC and Mittas, respectively, after the town issued an occupancy certificate. The parties’ lease contained a purported liquidated damages provision requiring the landlord to pay $500 per day for each day that the landlord failed to complete punch list items beyond the deadline, in addition to paying actual damages. Because the landlord took more than three years to finally complete the punch list work, the lease, as written, required the landlord to pay the tenant approximately $600,000 in liquidated damages on top of the modest actual damages.
The Mittas Court held that the lease’s liquidated damages clause was a clear unenforceable penalty. On its face, the clause’s reference to actual damages, in addition to $500 per day for delayed punch list work, guaranteed that the damages calculated under the clause would be greater, likely substantially greater, than the actual damages caused by a breach. Enforcement would have been a windfall to the tenant, but more problematically, an undue punishment or penalty to the landlord. The Court therefore invalidated the clause, and calculated and awarded only the actual proven damages incurred from the delayed punch list work. The tenant showed these actual damages through increased utility costs and payroll hours spent by its staff monitoring contractors trying to complete the job, a fraction of the stipulated sum.
Mittas is a reminder that parties to a contract must pay close attention to any proposed liquidated damages provision to ensure, at the outset, that the provision will likely pass muster if later scrutinized by a court. Liquidated damages may serve a valuable role in commercial leases, and in business and construction contracts. While there is a presumption of validity and courts do not require mathematical precision, parties must be able to show a reasonable connection between anticipated actual damages and the liquidated damages total. Moreover, such clauses cannot be drafted in a manner that calls for a penalty in the event of a breach. Efforts during contract negotiation to reasonably and genuinely approximate damages in the event of a breach are worthwhile in the short- and long-term. The parties’ reasonable expectations are more likely to be met with a properly drafted liquidated damages provision which may also avoid future costly litigation over its validity.
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