May 01, 2017 Articles

Obtaining Actual Damages in Addition to Liquidated Damages

Are liquidated damages an exclusive remedy? Drafters beware.

by Michael Hidalgo and Daniel Blau

Disputes over liquidated damages typically center on whether the amount of damages to which the parties stipulated is unreasonably high in comparison with the nonbreaching party's actual loss. If the disparity between the actual and the contracted-for damages is unreasonable in amount and as an approximation of damages at the time the contract was made, courts may treat the liquidated damages clause as a penalty and set it aside.

But What about When Liquidated Damages Are Too Low?
What remedies are available when the liquidated damages amount is too low compared with the loss the nonbreaching party actually suffered? California Civil Code section 1671(b) provides that a liquidated damages provision is enforceable "unless the party seeking to invalidate the provision establishes that the provision was unreasonable under the circumstances existing at the time the contract was made." By using a reasonableness standard, the law makes liquidated damages clauses vulnerable to challenges for both over- and undercompensating the nonbreaching party. In practice, however, courts routinely treat liquidated damages provisions as a limitation on liability and enforce liquidated damages provisions that undercompensate the nonbreaching party. Yet under certain circumstances, even when the contract contains a valid liquidated damages clause, the nonbreaching party can recover damages that go beyond those provided for in the contract or receive other forms of equitable relief in lieu of, or in addition to, the liquidated damages.

When parties stipulate to an amount of damages that must be paid in the event of a breach, the presumption is that the breaching party is only liable for that amount, even when the actual damages are dramatically higher than the amount of liquidated damages. In Better Food Markets, Inc. v. American District Telegraph Co., 253 P.2d 10 (Cal. 1953), for example, the plaintiff's actual damages were nearly $36,000 more than the amount of liquidated damages. The action arose after burglars robbed the plaintiff's food market of $35,930 in cash, and the alarm system that should have alerted the authorities of the robbery malfunctioned, allowing the thieves to escape with the loot. The liquidated damages clause limited damages to $50, which the court awarded to the food market.

This outcome did not sit well with one justice, who in his dissent suggested that the court treat liquidated damages clauses that undercompensate with the same penalty framework that applies to overcompensatory liquidated damages awards. As the justice explained, "the $50 provision here might just as well be held to be a penalty in the event of nonperformance by the defendant[;] it certainly bears no reasonable relation to the losses which the parties had in contemplation." Better Food Markets, 253 P.2d at 18 (Carter, J., dissenting). This proposed penalty framework for undercompensatory liquidated damages was never fully embraced, however. Three decades later, in another burglar alarm case where the plaintiff's jewelry store was robbed of over $100,000 in inventory, the court enforced a liquidated damages clause of $250 and capped the damages at that amount. Guthrie v. American Protection Industries, 206 Cal. Rptr. 834, 834 (Ct. App. 1984).

Scenarios under which a Court May Allow Additional Remedies
So when are additional remedies available to a plaintiff notwithstanding a valid liquidated damages provision? Courts provide for additional remedies in two situations. First, damages may be recovered for harms other than those contemplated by the liquidated damages clause. Second, a plaintiff may be able to enforce equitable remedies like specific performance in lieu of, or in addition to, the legal remedy of liquidated damages, provided that the contract is not explicit that the liquidated damages preclude equitable remedies.

Additional damages for injuries not contemplated by liquidated damages provision. With respect to the first category of cases, a plaintiff may recover for separate injuries that were not intended to be covered by the liquidated damages clause. For example, in International Fidelity Insurance Co. v. County of Chautauqua, 667 N.Y.S.2d 172 (App. Div. 1997), the court held that the surety for a delayed construction project was liable for actual damages even though the underlying construction contract contained a liquidated damages clause. The court reasoned that the defendant surety, by promising to complete the construction project for the company that defaulted on its obligations, took on duties that were new and distinct from those that it accepted under the terms of the original contract. Thus, the liquidated damages did not apply to those new duties, which were instead governed by the terms of the performance bond.

Similarly, in Palmco Corp. v. American Airlines, Inc., 983 F.2d 681 (5th Cir. 1993), the court awarded American Airlines both liquidated and cover damages from a flatware manufacturer that breached its contract with the airline to provide utensils for in-flight meals. The Palmco court distinguished between damages relating to the late delivery of the flatware, which triggered the liquidated damages, and the nondelivery of the utensils, which led the airline to purchase last-minute and more expensive utensils as cover for the nondelivery. The court held that damages stemming from the late delivery were not duplicative of those that stemmed from the nondelivery of the utensils and awarded the airline damages for each notwithstanding the liquidated damages clause.

Equitable remedies where exclusivity of liquidated damages is not explicit. Plaintiffs also may be entitled to equitable remedies in place of, or in addition to, the legal remedies the liquidated damages clause proscribe. The court in Logue v. Seven-Hot Springs Corp., 926 F.2d 722 (8th Cir. 1991), for example, nullified the liquidated damages provision and awarded specific performance in a land sale contract. The court reasoned that because the nonbreaching party had relied on subsequent amendments to the contract containing the liquidated damages provision, the stipulated damages were "inequitable" and were not intended to be the exclusive remedy following the part performance of the amended contract. Likewise, in North American Consolidated, Inc. v. Kopka, 644 F. Supp. 191 (D. Mass. 1986), the court held that a liquidated damages clause did not preclude specific performance in a contract for the sale of a hotel because the contract did not specify that liquidated damages would be the exclusive remedy in the event of a breach. Once again, the court inquired into the intent of the parties and set aside an otherwise valid liquidated damages provision.

Conclusion
While these cases illustrate exceptions to the rule that liquidated damages clauses are generally enforceable, they underscore the reality that courts will sometimes look for ways to circumvent otherwise valid liquidated damages clauses and find equitable outcomes in the face of inequitable liquidated damages clauses. Courts are effectively applying the penalty standard to undercompensatory stipulated damages agreements. To avoid such a result, practitioners seeking to limit future damage exposure for a client should make clear in the language of the contract that the liquidated damages provision is intended to be the exclusive legal and equitable remedy in the event of breach, and carefully draft the agreement to clarify the precise type of conduct, products, goods, or services for which the liquidated damages are intended to compensate the nonbreaching party in the event of a breach of contract.

Keywords: litigation, commercial, business, liquidated damages, penalty, overcompensatory, undercompensatory


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