Choice of Law and Liquidated Damages

Two weeks ago, I participated on a panel for a webinar on liquidated damages with three other panelists from New Jersey, Florida and Texas. In preparing with the other panelists, I was surprised to learn that while there are many common threads running through the law of liquidated damages across the country, there also are some startling differences depending upon which jurisdiction’s law controls.

In Massachusetts, for instance, courts look solely to what the parties knew at the time the contract was executed in evaluating the reasonableness of the liquidated amount in the contract. If the amount was reasonable at that time, the provision will be enforceable, even if it is undisputed that the plaintiff suffered no actual damages. See Kelly v. Marx  (where liquidated damages were awarded because the original purchaser failed to complete a transaction even though the seller later sold the property to another buyer for more than the original purchaser had agreed to pay).

The laws of other states, however, do not necessarily follow the same rule. In some, for instance, there are additional hurdles to be cleared beyond merely showing that the liquidated amount was reasonable at the time the parties entered into the agreement. See Lake Ridge Academy v. Carney, holding that:

[W]hen a stipulated damages provision is challenged, the court must step back and examine it in light of what the parties knew at the time the contract was formed and in light of an estimate of the actual damages caused by the breach. If the provision was reasonable at the time of formation and it bears a reasonable (not necessarily exact) relation to actual damages, the provision will be enforced.

Still other states make it easier to enforce a liquidated damages provision. According to the Supreme Court of New Jersey, “the modern trend is towards assessing reasonableness either at the time of contract formation or at the time of the breach.”

In light of this, choice of law in your contract can be critical. While liquidated damages may not be the most important aspect of your next contract, if you care about the enforceability of a liquidated damages provision — either because you do not want to have to prove your damages or because you want to know that there is a hard cap to your potential liability — don’t forget to check what the law is in the applicable jurisdiction. Failing to do so could result in a significant surprise if the liquidated damages clause is ever challenged.

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