Enforcement of an LD Clause is Not a Foregone Conclusion
Category | Briefing Papers
Hugh D. Brown is a shareholder in the firm’s Construction Law Department. He can be reached at 612.359.7663 or Hbrown@fwhtlaw.com. Zachary E. Coppola is an associate for the firm and can be reached at 612.359.7667 or Zcoppola@fwhtlaw.com.
Construction industry participants often use liquidated damages (“LD”) clauses to predictably allocate risk and try to limit the high cost proving actual damages, not to mention to risk of failing to do so. Once disfavored by courts, their reception has changed and LD clauses are now generally accepted. So much so, that it is easy to adopt the assumption that liquidated damages clauses will be all but rubber-stamped. But a recent case from the Minnesota Court of Appeals, Smart Construction & Remodeling v. Suchy, urges some caution here.[1] The case also provides guidance on how attorneys can better ensure their injured clients can still obtain a remedy if a liquidated damages clause is unenforceable.
Facts and District Court Ruling
A Minnesota Homeowner entered into an agreement with a Contractor to repair storm damage to his home and negotiate insurance coverage on his behalf. The agreement contained a liquidated damages provision calling for the Contractor to be paid thirty percent of the total insurance allocation plus the cost of materials in the event of breach by the Homeowner. Eventually, the Contractor obtained $100,000 worth of coverage from the Insurer, but before the Contractor began the work or purchased materials, the Homeowner informed the Contractor that he no longer wanted the Contractor to perform the repairs.
Upon the Homeowner’s repudiation, the Contractor brought suit for breach of contract seeking $30,000 under the liquidated damages clause of the agreement. The Contractor did not seek actual-expectation damages as an alternative remedy, instead bringing three equitable claims. At trial, the Contractor was able to prove $20,000 in damages stemming from the breach of contract with reasonable certainty, but did not offer any credible evidence in support of the amount of time or effort spent negotiating with the Insurance Company. The jury returned a verdict in favor of the Contractor awarding it $30,000 under the liquidated damages clause and $20,000 in reliance damages on the equitable claims. The district court overturned the jury’s findings, determining that the liquidated damages clause was an unenforceable penalty and that equitable relief was not available under a valid contract.
The Court of Appeals Decision and Takeaways
In an opinion affirming the trial court’s ruling on all counts, the Court of Appeals made clear that the level of deference given to a liquidated damages clause depends on whether the nature of the damages at issue can be calculated with reasonable certainty. Where this is the case, the party seeking to enforce a liquidated damages clause must overcome two hurdles. First, the party must prove their damages with reasonable certainty as if they were seeking actual-expectation damages. Second, the party must demonstrate that their actual damages are not “greatly disproportionate” to the amount sought under the liquidated damages clause. In contrast, when the nature of the damages at issue are not the type that can be proven with reasonable certainty, parties only need to prove that the sum of liquidated damages is not “manifestly disproportionate” to the amount of damage actually suffered.
Here, the Court found that the nature of the damages at issue, lost profits for the cancelled repair job and time spent negotiating with the insurance company, are the type that can be proved with reasonable certainty. Thus, the Court turned to the record to determine what damages the Contractor had actually proven with reasonable certainty. Agreeing with the lower court’s reasoning, the Court concluded that the Contractor only proved $20,000 in lost profits with reasonable certainty, as it did not keep track of the time spent negotiating with the Insurance Company. The Court rejected the Contractor’s argument that the liquidated damages clause released it from any duty to track these costs, finding it to be no excuse when the nature of the damages do not require speculation.
Next, the Court compared the Contractor’s actual damages to the amount sought under the liquidated damages clause to determine if the figures were “greatly disproportionate.” The Contractor argued that the figures were not disproportionate because its $20,000 in actual damages were only ten percent lower than the $30,000 in liquidated damages when put in the context of the $100,000 insurance claim. But the Court viewed the liquidated damages total as a fifty percent increase on the amount of actual damages, which it found “greatly disproportionate,” and hence, an unenforceable penalty.
After denying the Contractor relief under the liquidated damages clause, the Court then turned to the Contractor’s equitable claims. The Contractor argued that because it was seeking damages under the liquidated damages clause, it could not seek actual-expectation damages in the alternative. The court rejected the Contractor’s argument, stating unequivocally that plaintiffs may seek actual-expectation damages in the alternative when bringing suit to enforce a liquidated damages clause. Since contractual relief would have been available if requested, the Court concluded that the Contractor’s claims for equitable relief were not valid.
Takeaways: Ultimately, and despite the fact it proved $20,000 in actual damages, the Contractor was left with no remedy due to its failure to seek actual-expectation damages in the alternative. Three lessons arise:
First, do not assume a liquidated damages provision will be rubber-stamped by the courts. If damages can be measured with specificity, courts will probably find that they must be measured, and anything greatly in excess will be void as a penalty.
Second, even where there is a liquidated damages clause in place, contractors (and owners) should maintain cost records for any work involved to the extent possible. Doing so will significantly increase the likelihood of recovery if the court determines that the nature of the damages at issue can be calculated with reasonable certainty. If attorneys are concerned that presenting proof of actual damages will undermine their arguments in favor of enforcing the liquidated damages provision, they can bring a dispositive motion and attempt to litigate the validity of the liquidated damages provision before trial begins.
Third, even where liquidated damages are available, request actual damages in the alternative to avoid being caught without a remedy if the liquidated damages are held unenforceable.
[1] 2023 WL 5525071 (Minn. Ct. App. August 28, 2023).
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