There are a few methods of agreed remedies. First, settlement. Second, stipulate damages after breach (only litigate whether there was a breach). Third, draft a clause into the original contract outlining the cost of the damages for breach. Although this final method would save the court and parties considerable time and litigation expenses, the courts generally disfavor the solution. The only way to find a judicially enforceable liquidation damage is through passing the test outlined in Barrie School v. Patch.
Barrie School v. Patch
933 A.2d 382 (Md. App. 2007).
Barrie School is the plaintiff. They partially won at trial and appeal, but ultimately lost. Consequently, they appeal.
Question
First, is this a valid liquidation clause?
Second, is there a requirement to mitigate liquidation damages?
Rule
A valid liquidation clause has three main elements:
- Clear and unambiguous terms for a certain sum.
- The damages must be a reasonable compensation for anticipation of actual damages.
- The liquidation clause is final, not to be adjusted to account for actual damages.
The focus is on element number 2, did the parties intend the damages to be compensatory or a penalty.
Holding
This is a valid liquidation clause and there is no requirement to mitigate. Reversed.
Facts
Barrie School is a private school. The Patches had enrolled their daughter into the school and signed an enrollment agreement. As part of the agreement, the Patches were to inform the school by a deadline if they wish to cancel the agreement. If the Patches failed to cancel within the prescribed time, their $1,000 deposit would be lost and they would be required to pay for the full year tuition (about 13,000) (liquidation damages).
Well, the Patches withdrew their daughter and failed to notify Barrie within the prescribed time. When Barrie went to collect the tuition costs, the Patches refused to pay. Thus, Barrie sued to collect the damages. However, the Barries countered, seeking their 1,000 deposit and said that the contract was unenforceable for a variety of reasons, including the failure to mitigate.
Analysis
First, the court addresses whether this is a valid liquidation damages clause. A valid clause requires the court to examine the intention of the parties. If the intention was to compensate for lost damages, then the clause is valid. Otherwise, the clause would not be enforceable. Here, the clause is valid because the School had no idea what potential damages they may anticipate for missing one student and thus wanted to make sure that they were compensated for that loss (not to punish for withdrawal). Thus, this is a valid liquidation damage provision.
Second, the court determines that there is no duty to mitigate. Liquidation damages are already calculated and agreed to by the parties. This is partly because of the difficulty to calculate how much the school would lose for one student. As such, there is no way for the court to assess just how much would have been lost or gained through mitigation.
Finally, the court denies the “no-harm” defense. The no-harm defense is when a party cannot collect damages because there were not harmed. In the present case, the plaintiff filled more seats than they had originally budgeted for. Therefore, the defendants argued that there was no harm. However, the defense is denied because the courts do not wish to deprive the plaintiff of the bargained for agreement.
Additional Notes
The main issues here are whether this contract constituted a penalty and whether there was a requirement to mitigate.
Penalty v. Compensation:
Liquidation damages need to focus on the intent of the parties to compensate the plaintiff for loss rather than to penalize the defendant for failing to comply. If there is any doubt, the agreement should be treated as a penalty.
Mitigation:
There is no need to mitigate liquidation damages because those damages are designed to avoid the calculation. In other words, you already worked out the damages, no need to calculate later.
The defendant has the burden to show that liquidation damages should not be enforced.
Enforceable Also see Restatement § 356(1)
- When anticipated damages are in their nature uncertain and incapable of exact ascertainment.
- Unless the amount is grossly excessive and out of all proporitions to the damages that might reasonably have been expected from a breach.
- Reasonableness is judged at contract formation, not at the time of breach. Modern trends and the restatement has the court look at either or.
- If it turns out that liquidated amount is higher than the actuals, it will still be enforced unless it was a penalty. This goes the other way as well. See § 356(1).
Other types of liquidation damages appear in consumer (although limited), construction, employment, and real estate contracts.
Disclaimer
The content contained in this article may contain inaccuracies and is not intended to reflect the opinions, views, beliefs, or practices of any academic professor or publication. Instead, this content is a reflection on the author’s understanding of the law and legal practices.
