Liquidated damages Flashcards
Kemble v. Farren: rule of law
Parties may contract for liquidated damages, but the agreement must be clear that they are liquidated damages and not intended as a penalty.
Kemble v. Farren: facts
Farren (defendant) contracted with Kemble (plaintiff), the manager of Covent Garden Theater, to perform as the principal comedian for four seasons. The parties entered into a contract stipulating that £1,000 would be the damages should any party breach the contract in full in any way or breach any part thereof. The contract stated that this amount constituted liquidated damages and not a penalty. Farren refused to act during the second season. Kemble brought suit and the jury awarded him £750.
Kemble v. Farren: issue
Can parties contract for liquidated damages?
Kemble v. Farren: holding
Yes, parties can contract for liquidated damages. It is reasonable for parties to agree upon an amount for damages at the time of contracting. It is often difficult to accurately calculate damages and agreeing upon this amount can save time and expense at the time of trial. In the current matter, while the contract seems clear that the specified amount of £1,000 is liquidated damages, especially in light of the plain language that it is not intended as a penalty, an award of this amount is too overreaching. The contract would allow an award of this amount for even a very minor breach. It could be that the parties did not intend for the award to apply to even minor breaches, but that is the express language of the contract. Despite the language of the contract that the amount is not a penalty, the contract terms make it a penal sum. The verdict stands and the rule for increasing damages is discharged.
Wassenaar v. Towne Hotel: rule of law
A stipulated-damages clause will be upheld if the harm caused by breach was difficult to estimate at the time of contracting and the stipulated damages are not unreasonably disproportionate to such harm.
Wassenaar v. Towne Hotel: facts
Donald Wassenaar (plaintiff) became manager of the Towne Hotel under an employment agreement with Theanne Panos (defendant). The agreement was for a three-year term and included a stipulated-damages clause. The clause provided that Towne would fulfill the financial obligations of the agreement should Towne terminate the agreement prior to its expiration. Wassenaar was let go 21 months before the expiration of the contract, but he found work again within just a couple of months. Wassenaar sued for damages. Towne answered alleging that Wassenaar had failed to mitigate damages. The circuit court held that Wassenaar was not required to mitigate. The jury awarded $24,640, which represented what Wassenaar had calculated as his damages based upon the stipulated-damages clause. The court of appeals reversed the trial court decision and remanded the case for a new trial. The appeals court held the stipulated-damages clause void because it was a penalty. The court reasoned that the employee’s salary would be easy to calculate in the event of breach and that the formula, which provided an award of full salary without considering mitigation, was unreasonable. Wassenaar petitioned the Wisconsin Supreme Court for review on the issue of whether the stipulated-damages clause was enforceable.
Wassenaar v. Towne Hotel: issue
Will a stipulated-damages clause be upheld if the harm caused by breach was difficult to estimate at the time of contracting and the stipulated damages are not unreasonably disproportionate to such harm?
Wassenaar v. Towne Hotel: holding
Yes. A stipulated-damages clause will be upheld if the harm caused by breach was difficult to estimate at the time of contracting and the stipulated damages are not unreasonably disproportionate to such harm. Stipulated damages are evaluated under a reasonableness test. The factors to determine reasonableness are: (1) Was the award under the clause intended as damages or penalty? (2) Would it be difficult to calculate the award at the time of breach? and (3) Is the amount of damages stipulated a reasonable prediction of the injury caused by the breach?
Lake River Corp. v. Towne Carborundum: rule of law
Under Illinois law, a court will not enforce a liquidated damages clause that amounts to a penalty.
Lake River Corp. v. Towne Carborundum: facts
Carborundum Co. (Carborundum) (defendant) produces Ferro Carbo, which is a powder used in steel manufacturing. Carborundum entered into a distribution contract with Lake River Corp. (Lake River) (plaintiff), under which Lake River would bag the Ferro Carbo in its warehouses and ship it to Carborundum’s customers. Because Lake River had to purchase new equipment to fulfill the agreement, it insisted that Carborundum agree to ship a minimum quantity of Ferro Carbo within three years or pay the difference. Subsequently, demand for steel fell, and Carborundum did not meet the minimum shipments it had guaranteed. Lake River billed Carborundum for the $241,000 difference and refused to release the Ferro Carbo in its warehouses to Carborundum’s customers until Carborundum paid. Carborundum refused and spent $31,000 shipping in alternative product to fulfill its outstanding customer orders. Lake River sued in federal court under diversity jurisdiction, arguing that the minimum shipment requirement was effectively a liquidated damages clause. Carborundum counterclaimed, seeking to recover the Ferro Carbo Lake River retained and its expenses in replacing it, which totaled about $269,000. Lake River argued that it had not converted the Ferro Carbo, but rather that it had a lien. The judge sustained both parties’ claims. After offsetting the parties’ damages, Lake River owed Carborundum about $42,000. The parties cross-appealed to the United States Court of Appeals for the Seventh Circuit.
Lake River Corp. v. Towne Carborundum: issue
Is a purported “liquidated damages clause” enforceable when awarding the non-breaching party more than its likely damages from a breach?
Lake River Corp. v. Towne Carborundum: holding
No. Illinois law does not permit enforcement of contractual penalty clauses. A liquidated damages clause must reasonably estimate the damages likely to be caused by a breach, as understood at the time of contracting, to be enforceable. Further, such provisions are only permitted if actual damages would be hard to measure. Whether such a clause constitutes a penalty is a question of law, not fact. In edge cases, Illinois courts generally err on the side of deeming such a provision a penalty. There may be an argument that penalty clauses should be enforceable, especially when entered into by sophisticated parties. Still, doing so might deter parties from making efficient breaches, or breaches that result in a greater gain for the breaching party than cost to the non-breaching party. The theory, therefore, is that compensatory damages are preferable because they deter only inefficient breaches. This ignores the fact that agreeing to a penalty clause may give the signor credibility or some other value. That is a question for Illinois’s state courts, though, not a federal court sitting in Illinois. Here, the minimum shipment guarantee was a penalty. The provision guaranteed Lake River the full contract price, regardless of how much it performed or the actual costs it incurred. Carbordundum paid for the services Lake River actually performed, and the liquidated damages formula here would give Lake River a windfall. The clause provides for no reduction of Carborundum’s payment for the cost of performance that Lake River saved. Lake River did buy new equipment, but it can continue to use that equipment on other contracts. Lake River has not shown any actual damages on its part. The clause award is grossly disproportionate to probably actual harm suffered by Lake River and is therefore unenforceable. The ruling of the lower court is reversed, and the case is remanded for proceedings on proper damages under the common law.
