Liquidated damages in US contract law

Author: LegalEase Solutions 

RESEARCH FINDINGS

Issues:

  1. How liquidated damages need to be fashioned under general state contract law in the US states of law in Maryland, New York, Pennsylvania, Colorado, Texas, and California. 
  2. Do the damages have to be linked to likely, actual damages if the contract were breached in each of these states?
  3. Is there anything that states that liquidated damages are not supposed to be punitive in these states?
  4.  Is there any law regarding whether foreign nationals who are brought to the US by placement agencies can be bound to either agency placement contracts or employment contracts with the sponsoring organization if those contracts contain “breach fees” in the nature of liquidated damages with respect to these states?

Introduction:

Under US contract law, liquidated damages are intended to estimate damages in the event of a breach of contract.  As discussed in Berggren v Hill, 401 Ill App 3d 475, 479-80; 928 NE2d 1225, 1229 (2010), “ ‘Liquidated damages clauses do not limit a non-defaulting [sic] party’s remedies, but instead provide an agreed upon measure of damages.’ ” (quoting, Siegel v. Levy Organization Development Co., 182 Ill.App.3d 859, 861, 131 Ill.Dec. 340, 538 N.E.2d 715 (1989).

The following provides an analysis on the issue of liquidated damages as per specific state laws.

  1. MARYLAND
  1. How liquidated damages need to be fashioned under general state contract law in Maryland?

Under Maryland law, a “liquidated damages clause” is defined as a specific sum of money expressly stipulated by the parties to a contract as the amount of damages to be recovered by either party for a breach of the agreement by the other. Ecology Servs., Inc. v. GranTurk Equip., Inc., 443 F.Supp.2d 756 (D. Md. 2006).  Where parties named a sum to be paid as liquidated damages, the amount will be regarded as liquidated damages unless it is grossly excessive.

In Baltimore Bridge Co. v. United Rys. & Elec. Co. of Baltimore, 125 Md. 208, 93 A. 420, 421 (1915), court held that whether a sum named in a contract to be paid by a defaulted party is to be considered liquidated damages or merely a penalty is most difficult and perplexing inquiries encountered in the construction of written agreements.  This depends in a large measure at least upon the particular facts and circumstances of each separate case.

A stipulation to pay a specified sum upon the nonperformance of a contract is regarded as a penalty rather than as liquidated damages, if the intention of the parties as to its effect is at all doubtful or is of equivocal interpretation where the damages for a breach thereof are easily and exactly ascertainable.  It is equally well settled that a sum, if it be at all reasonable and is stipulated to be paid as liquidated damages for the breach of a contract, will be regarded as such, and not as a penalty, where from the nature of the covenant the damages arising from its breach are wholly uncertain and cannot be ascertained upon an issue of fact.

There are three essential elements of a valid and enforceable liquidated damages clause.

  • First, such a clause must provide in clear and unambiguous terms for a certain sum.
  • The liquidated damages must reasonably be compensation for the damages anticipated by the breach.
  • Liquidated damage clauses are by their nature mandatory binding agreements before the fact which may not be altered to correspond to actual damages determined after the fact.
  1. Do the damages have to be linked to likely, actual damages if the contract were breached?

In order to determine whether a sum named shall be considered liquidated damages or penalty, courts look at the language of the contract, the intention of the parties to be gathered from all of its provisions, the subject of the contract and its surroundings, the ease or difficulty of ascertaining the damages recoverable for a breach, the sum designated by the parties, and from all these factors determine what view shall be taken of the question in good conscience and equity. Turner v. Fremont, 170 Fed. 259, 95 C. C. A. 455.  If from the nature of the contract the damages cannot be calculated with any degree of certainty, the stipulated sum will usually be held to be liquidated damages, where they are so denominated in the instrument.

While the language used by the parties is instructive in determining the validity of a liquidated damages clause, the decisive element is the intention of the parties i.e., whether they intended that the sum be a penalty or an agreed-upon amount as damages in case of a breach and this is to be gleaned from the subject matter, the language of the contract and the circumstances surrounding its execution. Heister, 392 Md. at 156, 896 A.2d at 352 (internal citations and quotations omitted). Barrie Sch. v. Patch, 401 Md. 497, 933 A.2d 382 (2007).

Therefore, Maryland courts will uphold a liquidated damages clause as valid, and not a penalty, if it satisfies two primary requirements.  First, the clause must provide a fair estimate of potential damages at the time the parties entered into the contract.  Second, the damages must have been incapable of estimation, or very difficult to estimate, at the time of contracting. Heister, 392 Md. at 157, 896 A.2d at 352; Goldman, 251 Md. at 582, 248 A.2d at 158.

  1. Is there anything that states that liquidated damages are not supposed to be punitive in Maryland?

A liquidated damages provision will be held to violate public policy, and hence will not be enforced, when it is intended to punish, or has the effect of punishing, a party for breaching the contract, or when there is a large disparity between the amount payable under the provision and the actual damages likely to be caused by a breach, so that it in effect seeks to coerce performance of the underlying agreement by penalizing non-performance and making a breach prohibitively and unreasonably costly. 24 Richard A. Lord, Williston on Contracts § 65:1, at 216–23 (4th ed. 2002) (internal citations and footnotes omitted). Barrie Sch. v. Patch, 401 Md. 497, 933 A.2d 382 (2007).

  1. Is there any law regarding whether foreign nationals who are brought to the US by placement agencies can be bound to either agency placement contracts or employment contracts with the sponsoring organization if those contracts contain “breach fees” in the nature of liquidated damages with respect to these states?

There is no specific law that binds foreign nationals to agency placement contracts or employment contracts with sponsoring organization for breach fees amounting to liquidated damages other than the contract law of the state.

  1. Uniform Commercial Code (only applicable to contract for sale of goods).

The Uniform Commercial Code, as in force in Maryland, Code, Commercial Law Art., s 2-718(1) provides: “ ‘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.’” Lee Oldsmobile, Inc. v. Kaiden, 32 Md.App. 556, 562, 363 A.2d 270, 273-74 (1976)

  1. NEW YORK

 

  1. How liquidated damages need to be fashioned under general state contract law in New York?

In New York, the courts shall look to ascertain whether a contractual provision represents enforceable liquidated damages provision or an unenforceable penalty.  A contractual provision for liquidated damages will be upheld only if the amount fixed is a reasonable measure of the probable actual loss in the event of a breach, and the actual loss suffered is impossible or difficult to determine with precision. Cent. Irr. Supply v Putnam Country Club Assoc., LLC, 57 AD3d 934, 935 [2d Dept 2008].

Where a court finds a liquidated damages provision enforceable, the measure of damages for a breach will be the sum fixed in the clause, no more, no less. Cent. Irr. Supply v Putnam Country Club Assoc., LLC, 57 AD3d 934, 935 [2d Dept 2008].  Where, however, a liquidated damages provision is found to be an unenforceable penalty, the recovery is limited to actual damages proven. Id.

Hence, in New York the rule is well-established that a valid contractual provision for liquidated damages controls the rights of the parties in the event of a breach, notwithstanding that the stipulated sum may be less than the actual damages allegedly sustained by the injured party. X.L.O. Concrete Corp. v John T. Brady and Co., 104 AD2d 181, 184 [1st Dept 1984] affd, 66 NY2d 970, 489 NE2d 768 [1985].

  1. Do the damages have to be linked to likely, actual damages if the contract were breached?

A party requesting that a court strike down a liquidated damages provision as an unenforceable penalty must demonstrate that the damages are not a reasonable measure of the actual loss resulting from the breach, and the actual loss is readily ascertainable.  Zeer v Azulay, 50 AD3d 781, 785 [2d Dept 2008].  In New York, where a liquidated damages provision is deemed enforceable, “the measure of damages for a breach will be the sum in the clause, no more, no less.  However, if the clause is rejected as being a penalty, the recovery is limited to actual damages proven.” Id.

  1. Is there anything that states that liquidated damages are not supposed to be punitive?

In order to make the liquidated damages clause unenforceable in New York contracts, there must be a prima facie showing that the liquidated damages provision at issue was an unenforceable penalty. Whether a contractual provision represents an enforceable liquidated damages provision or an unenforceable penalty is a question of law. The party challenging a liquidated damages clause must establish either that actual damages were readily ascertainable at the time the contract was entered into or that the liquidated damages were conspicuously disproportionate to foreseeable or probable losses. United Tit. Agency, LLC v Surfside-3 Marina, Inc., 65 AD3d 1134, 1135 [2d Dept 2009].

The rule has evolved that when the damages flowing from the breach of a contract are easily ascertainable, or the damages fixed are plainly disproportionate to the injury, the stipulated sum will be treated as a penalty. X.L.O. Concrete Corp. v John T. Brady and Co., 104 AD2d 181, 184 [1st Dept 1984] affd, 66 NY2d 970, 489 NE2d 768 [1985].

  1. Is there any law regarding whether foreign nationals who are brought to the US by placement agencies can be bound to either agency placement contracts or employment contracts with the sponsoring organization if those contracts contain “breach fees” in the nature of liquidated damages?

There is no specific law that binds foreign nationals to agency placement contracts or employment contracts with sponsoring organization for breach fees amounting to liquidated damages other than the law of contracts.

  1. Uniform Commercial Code (only applicable to contract for sale of goods).

New York has also has adopted Article 2A of the Uniform Commercial Code.  The topic of liquidated damages is discussed in section 2—718 of the UCC.  Paragraph (1) states: ‘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.’ Nu Dimensions Figure Salons v. Becerra, 73 Misc.2d 140, 142, 340 N.Y.S.2d 268, 271 (N.Y. Civ. Ct. 1973).  Punishment of a promisor for breach, without regard to the extent of the harm that he has caused, is an unjust and unnecessary remedy and a provision having an impact that is punitive rather than compensatory. In re Nw. Airlines Corp., 393 B.R. 352, 357 (Bankr. S.D.N.Y. 2008).

  1. PENNSYLVANIA

 

  1. How liquidated damages need to be fashioned under general state contract law in Pennsylvania.

In Pennsylvania, the term “Liquidated damages” derived from contract law, denotes the sum a party to a contract agrees to pay if he breaks some promise, and which, having been arrived at by a good faith effort to estimate in advance the actual damage that will probably ensue from the breach, is legally recoverable if the breach occurs. Pantuso Motors, Inc. v Corestates Bank, N.A., 568 Pa 601, 798 A2d 1277 [2002].

Liquidated damage clauses are universally accepted as a necessary part of the law governing construction contracts in the state.  Parties to a contract may include a liquidated damages provision that ensures recovery in cases where computation of actual damages would be speculative, and these clauses are enforceable provided, at the time the parties enter into the contract, the sum agreed to is a reasonable approximation of the expected loss rather than an unlawful penalty.

  1. Do the damages have to be linked to likely, actual damages if the contract were breached?

Contracting parties may provide for pre-determined liquidated damages in the event one party fails to perform, particularly in circumstances where actual damages would be difficult to estimate in advance or to prove after a breach occurs. Pantuso Motors, Inc. v Corestates Bank, N.A., 568 Pa 601, 798 A2d 1277 [2002].  Nevertheless, Pennsylvania law does not require proof of damages to a mathematical certainty.  Rather, evidence of damages may consist of probabilities and inferences as long as the amount is shown with reasonable certainty.  However, to prove damages, a plaintiff must present sufficient evidence for the fact-finder to make an intelligent estimation, without conjecture, of the amount to be awarded. A.G. Cullen Const., Inc. v State Sys. of Higher Educ., 898 A2d 1145, 1160-61 [Pa Commw Ct 2006].

  1. Is there anything that states that liquidated damages are not supposed to be punitive?

A penalty, in contrast to liquidated damages, is fixed, not as a pre-estimate of probable actual damages, but as a punishment, the threat of which is designed to prevent the breach. Pantuso Motors, Inc. v Corestates Bank, N.A., 568 Pa 601, 798 A2d 1277 [2002].  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.  In determining whether a liquidated damages clause is an unenforceable penalty, one must examine the entire contract in light of its text, what it is about, the parties’ intentions, and the facility of measuring damages or lack thereof, so as to arrive at an equitable conclusion.

  1. Is there any law regarding whether foreign nationals who are brought to the US by placement agencies can be bound to either agency placement contracts or employment contracts with the sponsoring organization if those contracts contain “breach fees” in the nature of liquidated damages?

There is no specific statute that binds foreign nationals to agency placement contracts or employment contracts with sponsoring organization for breach fees amounting to liquidated damages other than the law of contracts.

  1. Uniform Commercial Code (only applicable to contract for sale of goods).

Section 2-718 of the Uniform Commercial Code of Sales titled ‘Liquidation Or Limitation of Damages’ necessarily refers to limitation as well as liquidation of damages.  It provides: “ ‘(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.’”  The Uniform Commercial Code comment to that subsection 1 is: “ ‘A term fixing unreasonably large liquidated damages is expressly made void as a penalty.  An unreasonably small amount would be subject to similar criticism and might be stricken under the section on unconscionable contracts or clauses.’” Wedner v. Fid. Sec. Sys., Inc., 228 Pa.Super. 67, 74-75, 307 A.2d 429, 434 (1973).

  1. COLORADO

 

  1. How liquidated damages need to be fashioned under general state contract law in Colorado?

In Colorado, in order to make a factual determination that liquidated damages clause is valid and enforceable, courts look into: (1) at time contract was entered into, anticipated damages in case of breach were difficult to ascertain, (2) parties mutually intended to liquidate them in advance, and (3) amount of liquidated damages, when viewed as of the time contract was made, was reasonable estimate of potential actual damages breach would cause. Bd. of Cnty. Comm’rs of Adams Cnty. v. City & Cnty. of Denver, 40 P.3d 25 (Colo. Ct. App. 2001).  In determining mutual intent of parties to contract, court consider contract’s subject matter and purposes and objects it purports to accomplish.  Courts may also consider circumstances surrounding creation of contract in making evaluation.

  1. Do the damages have to be linked to likely, actual damages if the contract were breached?

The measure of damages for breach of contract is that sum which places the nondefaulting party in the position that the party would have enjoyed had the breach not occurred. H.M.O. Sys., Inc. v. Choicecare Health Servs., Inc., 665 P.2d 635 (Colo. Ct. App. 1983).  However, unless it patently appears from contract itself that liquidated damages agreed upon are out of proportion to any possible loss, party asserting that damages clause constitutes a penalty has the burden of proving that contention. Jobe v. Writer Corp., 34 Colo. App. 240, 526 P.2d 151 (1974).

Liquidated damages provided by a contract must be reasonable, that is, not disproportionate to the actual damages which might have been anticipated by the parties upon breach of their agreement. Jobe v. Writer Corp., 34 Colo. App. 240, 526 P.2d 151 (1974).  In addition, if a contract stipulates a single liquidated damages amount for several possible breaches, the damages provision is invalid as a penalty if it is unreasonably disproportionate to the expected loss on the very breach that did occur and was sued upon. Bd. of Cnty. Comm’rs of Adams Cnty. v. City & Cnty. of Denver, 40 P.3d 25 (Colo. Ct. App. 2001).

The factors to be considered in determining whether amount designated as liquidated damages is in reality penalty, rather than reasonable estimate of actual damages, are whether parties intended to liquidate damages, whether amount of liquidated damages, when viewed as of time contract was made, was reasonable estimate of presumed actual damages that breach would cause, and whether, when viewed again as of date of contract, it was difficult to ascertain amount of actual damages that would result from breach. Rohauer v. Little, 736 P.2d 403 (Colo. 1987).

  1. Is there anything that states that liquidated damages are not supposed to be punitive?

In Colorado, the party attempting to avoid liquidated damages provision of contract has burden of proving that provision is unenforceable penalty.  A liquidated damages clause is unenforceable if it is in the nature of a penalty, an issue which is dependent upon whether the amount of liquidated damages, when viewed from the time of contracting, was a reasonable estimate of the presumed actual damages a breach would cause and whether it was difficult to determine the amount of damages that would result when viewed from the time of contracting. H.M.O. Sys., Inc. v. Choicecare Health Servs., Inc., 665 P.2d 635 (Colo. Ct. App. 1983).

Therefore, unless the contract on its face establishes that the stipulated liquidated damages are so disproportionate to any possible loss as to constitute a penalty, the party challenging the liquidated damages provision bears the burden of proving that fact. Rohauer v. Little, 736 P.2d 403 (Colo. 1987).

  1. Is there any law regarding whether foreign nationals who are brought to the US by placement agencies can be bound to either agency placement contracts or employment contracts with the sponsoring organization if those contracts contain “breach fees” in the nature of liquidated damages?

There is no specific statute that binds foreign nationals to agency placement contracts or employment contracts with sponsoring organization for breach fees amounting to liquidated damages other than the law of contracts.

  1. TEXAS

 

  1. How liquidated damages need to be fashioned under general state contract law in Texas?

In Texas, “Liquidated damages” are meant to be the measure of recovery in the event of nonperformance or breach of contract. Baker v. Int’l Record Syndicate, Inc., 812 S.W.2d 53 (Tex. App. 1991).  Liquidated damages will be enforced when court finds that the harm caused by breach is incapable or difficult of estimation and that the amount of liquidated damages is a reasonable forecast of just compensation, and if liquidated damages are not disproportionate to actual damages; if liquidated damages are disproportionate, they can be declared a penalty and recovery limited to actual damages proven. Id.

Under Texas law, to make a liquidated damages provision enforceable two conditions has to be met: (1) the harm caused by the breach is incapable or difficult of estimation, and (2) the amount of liquidated damages is a reasonable forecast of just compensation. Id.

  1. Do the damages have to be linked to likely, actual damages if the contract were breached?

In Johnson Engineers, Inc. v. Tri-Water Supply Corp., 582 S.W.2d 555 (Tex. Civ. App. 1979), court stated that if stipulated sum provided for in construction contract as liquidated damages for delay was shown to be disproportionate to actual damages, the stipulation would have to be declared to be a penalty and recovery limited to actual damages, but important factors to be considered in making this determination are the certainty or uncertainty of the actual damages occasioned by delay and the ease or difficulty or ascertainment or proof of such damages.

In order to meet burden of proving that contract provision for liquidated damages was in fact a penalty provision, party so contending was obliged to prove the amount of other party’s actual damages, if any, for the purpose of showing absence of an approximation between the actual loss and the stipulated sum. Johnson Engineers, Inc. v. Tri-Water Supply Corp., 582 S.W.2d 555 (Tex. Civ. App. 1979).

Additionally, liquidated damages must not be disproportionate to actual damages. If the liquidated damages are shown to be disproportionate to the actual damages, then the liquidated damages can be declared a penalty and recovery limited to actual damages proven. Baker v. Int’l Record Syndicate, Inc., 812 S.W.2d 53 (Tex. App. 1991).

  1. Is there anything that states that liquidated damages are not supposed to be punitive?

Party asserting that liquidated damages clause is, in fact, a penalty provision has burden of proof, and evidence related to difficulty of estimation and reasonable forecast must be viewed at the time the contract was executed. Johnson Engineers, Inc. v. Tri-Water Supply Corp., 582 S.W.2d 555 (Tex. Civ. App. 1979).

To meet burden of proving that liquidated damages clause is in fact penalty provision, party asserting that defense is required to prove amount of other party’s actual damages, if any, to show that liquidated damages are not an approximation of stipulated sum. Commercial Union Ins. Co. v. La Villa Indep. Sch. Dist., 779 S.W.2d 102 (Tex. App. 1989).

  1. Is there any law regarding whether foreign nationals who are brought to the US by placement agencies can be bound to either agency placement contracts or employment contracts with the sponsoring organization if those contracts contain “breach fees” in the nature of liquidated damages?

There is no specific statute that binds foreign nationals to agency placement contracts or employment contracts with sponsoring organization for breach fees amounting to liquidated damages other than the law of contracts.

  1. CALIFORNIA

 

  1. How liquidated damages need to be fashioned under general state contract law in California?

In California, the objective of a liquidated damages clause is to stipulate a pre-estimate of damages in order that the contracting parties may know with reasonable certainty the extent of liability in the event of breach. El Centro Mall, LLC v. Payless ShoeSource, Inc. (2009) 174 Cal.App.4th 58 [94 Cal.Rptr.3d 43].  Liquidated damages are viable if it is established that at the formative stages of the contract it was mutually agreed that damages from a breach would be impracticable or extremely difficult to determine with certainty, and that the amount or formula stipulated by the parties represented a reasonable endeavor to ascertain what such damages might be. Vrgora v. Los Angeles Unified School Dist. (1984) 152 Cal.App.3d 1178 [200 Cal.Rptr. 130].

In California, facts must be pleaded and proved from which the court can say as a matter of law that the contract for liquidated damages is valid because from the nature of the case it would be impracticable or extremely difficult to fix the actual damage.  Hence, the mere stipulations of the contract are insufficient for that purpose. Sunmaid Raisin Growers of California v. Paul A. Mosesian & Son (1928) 90 Cal.App. 1, 6 [265 P. 828, 830].

  1. Do the damages have to be linked to likely, actual damages if the contract were breached?

In Vrgora v. Los Angeles Unified School Dist. (1984) 152 Cal.App.3d 1178 [200 Cal.Rptr. 130], it was held that one of the major purposes of allowance of liquidated damages is to provide a remedy where damages are not easily ascertainable, and thus while liquidated damages must fit within conventions of reason, they are not necessarily approximations of actual damage suffered.  Evidence required to support a foundational-facts determination that parties, at time of contracting, made a reasonable endeavor to arrive at a liquidated damages figure which bears a reasonable relationship to actual damages necessarily requires proof that both parties participated in process. Barbera v. Sokol (1980) 101 Cal.App.3d 725 [161 Cal.Rptr. 843].

However, court has also held that even where the parties to the contract for liquidated damages have by written stipulation agreed that it would be impracticable and extremely difficult to fix the actual damages, if the facts do not support such stipulation it cannot be enforced. Sunmaid Raisin Growers of California v. Paul A. Mosesian & Son (1928) 90 Cal.App. 1, 6 [265 P. 828, 830].

Moreover, courts perform a “reasonable endeavor test” to determine the validity of a liquidated damages provision, measured at the time of contracting: the amount set as liquidated damages must represent the result of a reasonable endeavor by the parties to estimate a fair average compensation for any loss that may be sustained.

  1. Is there anything that states that liquidated damages are not supposed to be punitive?

In El Centro Mall, LLC v. Payless ShoeSource, Inc. (2009) 174 Cal.App.4th 58 [94 Cal.Rptr.3d 43], it was observed that in order to avoid liability under liquidated damages provision in a lease for retail space in a shopping center, tenant had the burden of proof to demonstrate the liquidated damages provision was not intended by the parties to be a reasonable estimate of damages, but was instead a penalty.

Whether provision in a contract is for liquidated damages or for a penalty, depends on intent of parties as evidenced by entire agreement, construed in light of circumstances under which it was made, and such intent is to be determined at time contract is entered into. Hanlon Drydock & Shipbuilding Co. v. G.W. McNear, Inc. (1924) 70 Cal.App. 204 [232 P. 1002].

  1. Is there any law regarding whether foreign nationals who are brought to the US by placement agencies can be bound to either agency placement contracts or employment contracts with the sponsoring organization if those contracts contain “breach fees” in the nature of liquidated damages?

There is no specific statute that binds foreign nationals to agency placement contracts or employment contracts with sponsoring organization for breach fees amounting to liquidated damages other than the law of contracts.