When thinking about liquidated damages, most people focus on the fact that a properly drafted liquidated damages provision will enable the non-breaching party to recover a set amount without ever having to prove how much, if any, actual damages were incurred. What people often forget to consider, however, is that a liquidated damages clause also sets a ceiling for damages.… Keep reading
liquidated damages provisions
More than once, an in-house counsel has called me up wanting to sue a former employee because s/he has been “bad-mouthing” the company despite having agreed not to disparage the company as part of a settlement or severance agreement. Nevertheless, I Often have had to give the client the bad news that, in light of the actual contractual language, there would be little chance of prevailing and/or, even if we did prevail, the legal fees probably would exceed the damages we might reasonably expect to recover. The good news for those of you reading this post, however, is that there are three simple steps you can take to greatly enhance the effectiveness and enforceability of any non-disparagement clauses you would like to implement in the future. … Keep reading
Memorializing an agreement in a written contract serves two primary purposes. First and foremost, a written contract should clearly set out the deal terms so that there is little or no chance of a misunderstanding as to what the parties’ rights and obligations are. Further, to be sure that they get the deal terms right, in-house counsel often turn to business people involved in the deal because they are the experts on the deal terms.
The second reason to have a written contract is to set out the “Rules of Engagement” that will apply if a dispute arises between the parties. Such Rules, on which I have written in other posts, include choice of law provisions, forum selection clauses, liquidated damages provisions, and arbitration clauses, just to name a few. Surprisingly, however, and in contrast to in-house counsels’ willingness to consult with business people about the deal terms in a contract, in-house counsel often are reluctant to consult with experts on the Rules of Engagement, i.e., experienced litigators. Whether the reason for this is a psychological aversion to placing too much emphasis on what might go wrong with a deal before it is fully in … Keep reading
As suggested in “The Effective Use of Liquidated Damages Provisions,” there can be a fine line between an enforceable liquidated damages provision and an unenforceable penalty clause. Thus, when drafting an agreement, it is important to keep in mind that a payment-for-breach provision will only be enforceable if, at the time of drafting:
- It would be difficult to determine the damages that would be caused if the contemplated breach were to occur; and
- The amount of the of the liquidated damages is a reasonable estimate of the actual damages that your company would suffer if there were a breach.
In light of these overarching principles, be sure that the contract expressly states that:
- All parties agree that if a breach were to occur, it would be difficult to determine actual damages;
- Based on what the parties presently know (include specifics if you can), they agree that $X is a reasonable estimate of the damages that would accrue if a breach occurred in the future; and
- All parties agree that the amount of liquidated damages is fair and reasonable and would not act as a penalty to the breaching party.
The Basics of Liquidated Damages Provisions
A liquidated damages provision fixes the amount of money one party will pay to the other if a breach occurs. Because the law of contracts is designed to be compensatory, however, a payment-for-breach-clause that is penal will not be enforceable (Some reasons for this are discussed in “Why Not Enforce ‘Penalty’ Liquidated Damages Clauses?”). Accordingly, even if a contract conspicuously says: “If the purchaser is one second late to the closing, it shall pay the seller $10,000,000,” that clause very likely will be deemed to be an unenforceable penalty.
So what makes for a valid liquidated damages provision? There are two essential conditions:
- At the time the contract was executed, it must have been the case that it would have been difficult to determine the damages caused by a breach.
- At the time the contract was executed, the amount of the monetary payment designated must have appeared to have been a reasonable estimate of the expected damages for the contemplated breach.