Liquidated Damages – a remedy for breach of contract

Liquidated Damages – a remedy for breach of contract

In the context of commercial contracts the term “liquidation” means to fix or establish the damages owed in the event of a breach of contract.  Rather than add the calculation of the dollar amount of damages for breach to a list of items in dispute, a carefully drafted liquidated damages (“LD’s”) provision can establish the dollar damages for breach at the outset of the relationship.  The law on the enforceability of LD’s varies slightly from state to state but the general rules are well settled and fairly easy to implement.  Using a well crafted LD’s provision in a contract can offer benefits to both parties as they allocate particular transaction risks.

For sellers of goods, the Uniform Commercial Code (“UCC”) provides a simple basis for recovery of liquidated damages as a remedy for breach of contract:

UCC § 2-718. Liquidation or Limitation of Damages; Deposits.

(1) Damages for breach by either party may be liquidated in the agreement but only at an amount which is reasonable in the light of the anticipated or actual harm caused by the breach, the difficulties of proof of loss, and the inconvenience or nonfeasibility of otherwise obtaining an adequate remedy. A term fixing unreasonably large liquidated damages is void as a penalty.

Note, this section of Article 2 above is not an actual liquidated damages provision but rather it serves as a basis for enforceability in sales contracts.  Most states have adopted versions of the UCC Article 2 for application within their jurisdiction.  The UCC provision sets forth elements that are typically considered when actual LD provisions are litigated to determine intent and enforceability.

Likewise the Restatement (Second) of Contracts Section 356(1) also provides a basis for LD’s as a remedy in breach of contract cases in the event the UCC does not apply:

§ 356. Liquidated Damages and Penalties

(1) Damages for breach by either party may be liquidated in the agreement but only at an amount that is reasonable in the light of the anticipated or actual loss caused by the breach and the difficulties of proof of loss. A term fixing unreasonably large liquidated damages is unenforceable on grounds of public policy as a penalty.

Both the UCC and the Restatement seek to serve the goal of allowing the parties to stipulate damages for breach at the time of contracting to save the time of the courts and the parties in the event of litigation and thereby reduce the cost of resolving disputes.  This is especially true where the damages are small and best resolved by the parties.  The parties should be free to negotiate fair compensation for a breach so long as the remedy does not become punitive in nature crossing the line into an unenforceable penalty.

In most instances an LD provision will be upheld if the damages would be:

      • Uncertain as to amount and difficult to prove;
      • Not unconscionable and disproportionate in amount as related to reasonable intentions of the parties;
      • Consistent with conclusion that the parties intended damages in such amount would follow a breach.

The following is a sample provision that may be appropriate for use as a basis for developing a contract specific remedy:

“The parties acknowledge that given the uncertainty they anticipate associated with the ability to calculate the buyer’s damages for the seller’s failure to deliver the goods in accordance with the schedule, the amount stipulated herein as liquidated damages is a good faith estimate of reasonable compensation for the damages resulting from late delivery and that such liquidated damages are not intended, and shall not be construed, as a penalty.”       

Note: The sample provision above is for illustration purposes only and is not intended for use without appropriate review in your jurisdiction.

Comments (2)

  1. Matt - Reply

    September 20, 2013 at 3:39 pm

    In a typical commercial lease, remedies are most often spelled out as cumulative. When a provision exists where liquidated damages are associated with a violation of the provision, the LD provision seemingly should trump any further claim for damages since the LD provision has already established an agreed-on amount for damages. Am I wrong about this?

    • Steven E. Pazar - Reply

      September 23, 2013 at 8:25 pm

      Thanks for the excellent question. Cumulative remedy provisions are often overlooked in contract negotiations but are an interesting topic. Typically I like to limit remedies to those articulated in the contract itself – a sole remedies concept. It is difficult to answer your question with precision as the best answer is dependant on state law and the factual details. However, my general thoughts are as follows: One of the basic rules of contract construction is that the specific overrules the general. So if you have a specific provision at issue and it contains stipulated liquidated damages (“LD’s”) then that should trump selection of another remedy (or at least another method for calculating the actual damages in this instance). Depending on whether you are seeking to enforce the LD provision or not, suggesting that it is now possible to calulate with ease and accuracy the actual damages via another remedy may undermine the enforceability of the LD provision. Recall the parties decided at the outset that determining the actual damages upon a breach or default was too difficult and stipulated the LD’s instead. Assuming the LD provision is enforceable then it is not a question of trumping as much as an issue of the right to select an alternate remedy. No one should be taking the position that the LD’s are owed and then actual damages must also be paid on top of that amount pursuant to another remedy. The “cumulative” does not refer to an ability to stack the damages. There is a very recent commercial real estate case from the Massachusetts Supreme Court (275 Wash. St. Corp. v. Hudson River Int’l., LLC (Mass 2013)) which discusses cumulative remedies, indemnification and liquidated damages. Here is a redacted section of the opinion: “The landlord contends that, … , it is entitled now under the “cumulative remedies” clause … of the lease to posttermination damages under the common law of contract. [The cumulative remedies clause], however, does not create a remedy under the contract; it merely declares that a party’s election of one remedy does not foreclose the party’s ability to seek another remedy that is available “at law or in equity,” and thereby preserves the parties’ ability to pursue alternative available remedies.” If you can’t easily get this opinion online please email me for an electonic version. I hope this is helpful. Best, Steve

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