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April 25, 2018 Practice Points

Delaware Court Casts Doubt on the Enforceability of Liquidated Damages Provision in Technology Services Agreement

Even provisions agreed to by sophisticated commercial parties may be invalid if they would provide a windfall to the non-breaching party

by Travis S. Hunter

Liquidated damages provisions are common in many commercial contracts. Such provisions allow parties to determine in advance the measure of damages of a party that breaches the agreement. Not all such provisions are enforceable, however. Under Delaware law, determining whether a stipulated sum is a proper liquidated damages provision requires a two-part test. S.H. Deliveries, Inc. v. TriState Courier & Carriage, Inc., 1997 WL 817883, at *2 (Del. Super. Ct. May 21, 1997). First, are the reasonably anticipated damages difficult to ascertain at the time of contracting because of indefiniteness or uncertainty? Id. Second, is the amount stipulated either a reasonable estimate of future damages or reasonably proportionate to the damages that actually have been caused by the breach? Id. Both questions must be answered in the affirmative for a liquidated damages provision to be enforceable. Id.

Recently, in DecisivEdge, LLC v. VNU Group, LLC, 2018 WL 1448755 (Del. Super. Ct. Mar. 19, 2018), the Delaware Superior Court's Complex Commercial Litigation Division (CCLD) was asked to analyze the enforceability of a liquidated damages provision in a technology services agreement when considering a motion to dismiss. In relevant part, section 19 of the parties' agreement allowed for early termination by the defendant and identified certain fees that would follow as a result. The parties, however, disputed whether the early termination provision was enforceable and whether the plaintiff should be entitled to early termination fees. The defendant argued that the fee established in section 19 was an unenforceable liquidated damages provision because any damages for early termination were easily ascertainable, given that the parties' agreement laid out the amounts to be paid for each work period. In contrast, the plaintiff argued that section 19 was an enforceable liquidated damages provision because the damages were not easily ascertainable at the time of contracting. The plaintiff also argued that since the termination fee from section 19 was only a fraction of the total damages owed, it was prima facie reasonable. Finally, the plaintiff claimed that determining the validity of section 19 was a question of fact not appropriate for the court to decide on a motion to dismiss.

Although the court agreed with the plaintiff that determining the validity of the early termination fee was not properly resolved on a motion to dismiss, the court also stated its "impression" that the contract clearly stated the amount due and that the plaintiff's argument was "suspect." Id. at *7. However, the motion was denied because the court was "not in a position to find the termination fee unenforceable without additional discovery by the parties." Id.

Although the DecisivEdge court reserved ruling on the enforceability of the liquidated damages provision for another day, it is not unthinkable that a liquidated damages provision would be held unenforceable in a contract with a readily ascertainable value. Indeed, many courts have reached that exact conclusion. In Lake River Corp. v. Carborundum Co., 769 F.2d 1284, 1286 (7th Cir. 1985), for example, the Seventh Circuit held that the liquidated damages provision was an unenforceable penalty "because it is designed always to assure [the plaintiff] more than its actual damages" where the liquidated damages formula was the full contract price minus the amount already invoiced to the defendant. Id. at 1290. Similarly, in A.V. Consultants, Inc. v. Barnes, 978 F.2d 996, 1001 (7th Cir. 1992), the Seventh Circuit affirmed a district court's holding that a purported liquidated damages provision was unenforceable where the formula was the balance of certain administrative fees due for the remaining contract period. Other cases have reached similar results. See Easton Telecom Servs., L.L.C. v. CoreComm Internet Group., Inc., 216 F. Supp. 2d 695 (N.D. Ohio 2002) (holding that provision requiring immediate payment of the full amount due for the remainder of the term was an unenforceable penalty not based on any real estimation of damages for breach); Poinsettia Dairy Prods., Inc. v. Wessel Co., 166 So. 306 (Fla. 1936) (holding provision unenforceable that required immediate payment of the full amount due for the remainder of the term).

Based on these and other authorities, even sophisticated commercial parties must remember that not all liquidated damages provisions are enforceable. Where the value of a contract is readily ascertainable, liquidated damages provisions are particularly suspect and may be held invalid—particularly where they would provide a windfall to the non-breaching party by requiring immediate payment of the full contract value.

Travis S. Hunter is counsel at Richards Layton & Finger, P.A., in Wilmington, Delaware.

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