Contracts may sometimes contain a provision, which states the damages that will be due in the event of a default or breach. These predetermined damages are known as liquidated damages and a provision that imposes them is enforceable only if they are not punitive in nature. If they are punitive, they constitute a penalty, which is unenforceable.
To determine whether a liquidated damage clause is enforceable, courts will examine the subject matter of the contract and the ease or difficulty of measuring a potential breach or default in damages. They may also compare the amount of the stipulated sum to the value of the subject matter of the contract and the probable consequences of the breach or default. If the provision is reasonable at the time of formation and it bears a reasonable relation to actual damages, it is enforceable.
A recent ruling in the case of Fleming v. Kent State University illustrates one court’s analysis of the question as to whether damages resulting from a potential breach or default were uncertain and difficult to prove at the time the parties entered into the contract so as to support the contract’s liquidated damages provision. In that case, a football coach who was the defensive coordinator for a college team had a twenty-eight (28) month employment contract with Kent State. The contract provided for a starting salary of $71,000.00 with cost of living or merit based raises. It also provided that the coach would receive bonuses of specific amounts, if the football team achieved certain accomplishments. For example, the coach would receive a $6000.00 bonus if the team made a bowl appearance.
The liquidated damage provision of the contract stated that, in the event of termination without cause prior to expiration, the party that initiated the termination would be required to pay the other party an agreed upon termination cost. If Kent State initiated the termination, it would be required to pay the coach the balance of the then in effect base salary due for the remaining term.
After Kent State was found to have prematurely terminated the contract without cause, the coach sought liquidated damages pursuant to the contract. The coach supported his claim that, at the time of contracting, damages were uncertain and not easily susceptible to proof by asserting that his bonuses were dependent on the team’s academic and athletic performances, that he could receive merit-based and cost of living salary increases and that the contract contemplated the possibility that his coaching position would lead to additional income from sources such as television programs and endorsement or consultation contracts with managers of athletic equipment. Kent State, on the other hand, asserted that the liquidated damages constituted an unenforceable penalty because, at the time of the breach, the coach did not have a contract related to athletic equipment, had presented no evidence of additional income earned from any other source and/or evidence that he would have been entitled to any bonuses under the contract.
When it analyzed the issue, the court noted that, in evaluating the validity of liquidated damages, the proper focus is on whether the damages that the coach would have suffered in the event of a breach were uncertain in amount and difficult to prove at the time the parties entered into the contract rather than at the time of the breach or default. In this case, the court found that, at the time of contracting, neither Kent State nor the coach could predict whether the team would achieve any of the goals that would have entitled the coach to bonuses under the contract. Moreover, it was clear to the court that collateral business opportunities (such as endorsements) whose value was difficult to predict at the time the contract was made would have been available the coach throughout the term of the contract. Based upon these facts, the court concluded that damages were, in fact, uncertain and difficult to prove at the time of contract formation. Thus, the court concluded that the liquidated damage provision was enforceable, at least with respect to the uncertainty requirement. The court remanded the case to trial court to determine whether the other required elements for enforceability (that the contract was not unreasonably disproportionate in amount and that the liquidated damages provision reflected the parties’ intent) were fulfilled.
Kathy Delaney Winger (www.kathydelaneywinger.com) is a banking and business attorney who represents banks, credit unions, financial services companies and businesses in commercial and corporate transactions.
The information presented here is for general purposes only. It does not constitute legal advice and does not create an attorney-client relationship.