By: Alexander R. Zwillinger, Esq.

The goal of any contract is predictability. The parties want to know from the outset what their rights and obligations are, what they need to do, and what they can expect from the other side. To that end, a well-drafted contract will be clear, unambiguous, and thorough about each side’s promises and expectations. It will consider and address in advance as many risks and contingencies as possible.

But even the best contracts are breached, leaving the parties to calculate and prove their damages. Doing so, however, can be difficult. It is not always easy to quantify the ways a breach caused injury, presenting a prospective challenge for evaluating whether it makes sense to wait until a breach has occurred, or a retrospective challenge of proving actual damages after the fact.

To address those challenges, parties can negotiate the damages in advance through liquidated damages provisions. A liquidated damages provision is a predetermined amount or formula for calculating damages for breach of contract, agreed to at the time of contracting.[1] Ideally, liquidated damages should be the parties’ best estimate of what their damages would be in the event of breach.

In our practice at Kenney & Sams, we often see liquidated damages provisions in construction contracts, providing a specified cost for delays. For example, a construction contract might put a fixed amount for each day beyond the contractual completion date, setting in advance precisely the consequences for missing agreed upon deadlines to account for things like debt service and taxes. We also see liquidated damages provisions in commercial contracts tied to restrictive covenants, such as non-solicitation and non-disclosure agreements. For example, the parties may devise a formula for calculating the damage for each customer stolen or trade secrets disclosed. In both contexts the purpose is to provide predictability and certainty.

Liquidated damages provisions will only be enforced, however, if they are not a penalty. The key is that the amount of liquidated damages specified in a contract must be reasonably related to the anticipated or actual loss caused by the breach.[2] An unreasonable liquidated damages provision is unenforceable on public policy grounds as a penalty.[3] Massachusetts courts will only enforce a liquidated damages clause provided each of two criteria are met: (1) at the time of contracting, the amount of actual damages flowing from a breach was difficult to determine; and (2) the amount agreed upon as liquidated damages was a reasonable forecast of damages expected to occur in the event of a breach.[4] If either of those things is missing, the provision is unenforceable. Importantly, the evaluation is at the time of contracting. The court will not consider the actual damages after the breach of contract as long as the estimate before the breach was reasonable.[5]

It is essential to draft enforceable liquidated damages provisions to accomplish the predictability they are supposed to provide. Be sure they are non-punitive, reasonable, and used only when it would be hard to calculate actual damages in case of a breach. Think carefully about and discuss fully with the counterparty exactly why you believe liquidated damages are appropriate in the context of your specific agreement.  Make a record of how you calculated the specified damages and why it is reasonable and fair for both sides.

We recently won a motion for summary judgment attacking an liquidated damages provision as an unenforceable penalty, the result of which was a total and immediate shift in the trajectory for the case. Read more here. Whether you need help drafting or enforcing a liquidated damages provision that can withstand scrutiny, Kenney & Sams is ready to help.

Anyone with questions should consult with a Kenney & Sams business litigation attorney.

 

[1] Factory Realty Corp. v. Corbin-Holmes Shoe Co., 312 Mass. 325, 331 (1942) (defining liquidated damages as “a sum fixed as an estimate made by the parties at the time when the contract is entered into, of the extent of the injury which a breach of the contract will cause.”).

[2] Colonial at Lynnfield, Inc. v. Sloan, 870 F.2d 761, 764 (1st Cir. 1989), citing Security Safety Corp. v. Kuznicki, 350 Mass. 157, 158 (1966); A–Z Servicenter v. Segall, 334 Mass. 672, 675 (1956); Lynch v. Andrew, 20 Mass. App. 623, 627 (1985).

[3] Lynch v. Andrew, 20 Mass. App. 623, 627 (1985); Warner v. Wilkey, 2 Mass. App. 798, 799 (1974); Restatement (Second) of Contracts § 356(1); Restatement of Contracts § 339.

[4] NPS, LLC v. Minihane, 451 Mass. 417, 420 (2008), citing Cummings Props., LLC v. National Communications Corp., 449 Mass. 490, 494 (2007).

[5] Kelly v. Marx, 428 Mass. 877, 878 (1999) (endorsing the “single look” approach).

 

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