Chapter 17 LIQUIDATED DAMAGE CLAUSES

• Jurisdiction: New York

Chapter Seventeen

Liquidated Damage Clauses

I. Liquidated Damage Clauses, Anticipated Damages, Penalty, Compelling Compliance

The central objective behind contract remedies is compensatory, not punitive.³⁰⁰¹ The law generally presumes that the primary purpose of a contract, not expressly stated to be an option, is to secure performance of the act promised and not nonperformance. A punitive measure of damages is not applied routinely for breach of contract, and bad faith requires an extraordinary showing of a disingenuous or dishonest failure to carry out a contract.³⁰⁰²

While it is true that a promisor can refuse to perform its promise and, further, that in most cases the only liability for doing so is in damages, this does not necessarily mean that when one enters into a contract he in effect agrees to perform or pay damages at her option. Rather, under ordinary contracts the promisor's duty is to perform the contract, and the promisee is entitled to the bargained-for performance unless the promisor has reserved as an alternative in the contract the choice of making a money payment to the promisee.³⁰⁰³

In Chung, Yong Il v. Overseas Nav. Co. Ltd.,³⁰⁰⁴ the Eleventh Circuit stated:

Most litigation of liquidated damages provisions involves claims by the breaching party that a clause should not be enforced because the agreed upon damages are excessive. Here, EFD and Deutsch argue that the payment of the liquidated sum should allow them to escape their obligation under the contract. The presence of a liquidated damages provision in a contract is not ordinarily construed in such a fashion. See Restatement Second, Contracts § 361, comment a (1979) ("Merely by providing for liquidated damages, the parties are not taken to have fixed a price to be paid for the privilege not to perform.").

Generally, penalty clauses and even liquidated damages clauses are inserted to assure performance and to avoid litigation as to quantum of damages. The goal is to induce performance by making delay or breaches unprofitable.³⁰⁰⁵ Although in terrorem ³⁰⁰⁶ clauses are enforced in will contexts,³⁰⁰⁷ their insertion into separation agreements is not uncommon.³⁰⁰⁸

Liquidated damages constitute agreed-upon compensation in order to satisfy any loss or injury flowing from a breach of contract.³⁰⁰⁹ A liquidated damage provision is an estimate, made at the time of the agreement, of the extent of the injury that would be sustained as a result of a breach of the agreement.³⁰¹⁰ A liquidated damages clause which is reasonable precludes any recovery of actual damages. This is so even though the stipulated sum may be less than the actual damages sustained by the injured party.³⁰¹¹ As a general rule, where the delays are caused by the mutual fault of the parties, a liquidated damage clause is abrogated and each party must resort to an action to recover its actual damages.³⁰¹² Mitigation of damages is not relevant when there is a valid liquidated damages clause.³⁰¹³

Where the parties have not clearly expressed the duration of a contract, the courts will imply that they intended performance to continue for a reasonable time.³⁰¹⁴ Unless a contract expressly provides for perpetual performance, the law will not imply that a contract calling for continuing performance is perpetual in duration. Moreover, in the absence of an express term fixing the duration of a contract, the courts may inquire into the intent of the parties and supply the missing term if a duration may be fairly and reasonably fixed by the surrounding circumstances and the parties' intent.³⁰¹⁵

Parties to a contract have the right to agree to liquidated damage clauses, provided that the clause is neither unconscionable nor contrary to public policy³⁰¹⁶—public policy is firmly set against the imposition of penalties or forfeitures for which there is no statutory authority.³⁰¹⁷

The freedom of contract does not embrace the freedom to punish, even by contract.³⁰¹⁸ Punitive damages are not recoverable because defendant's alleged conduct is not actionable as a tort independent of its alleged failure to perform its contractual obligations.³⁰¹⁹ The mere allegation that the alleged breach of contract was maliciously intended or constituted willful misconduct does not render the breach of contract claim a separate and independent tort claim.³⁰²⁰ All damages are in some degree punitive and preventive, but they are not so called unless they exceed just compensation for the harm that is actually suffered.³⁰²¹

Reads Co., LLC v. Katz³⁰²² stated:

"[P]unitive damages are not recoverable in an ordinary breach of contract case, as their purpose is not to remedy private wrongs but to vindicate public rights" (Tartaro v. Allstate Indem. Co., 56 A.D.3d 758, 758, 868 N.Y.S.2d 281). "Punitive damages are only recoverable where the breach of contract also involves a fraud evincing a high degree of moral turpitude, and demonstrating such wanton dishonesty as to imply a criminal indifference to civil obligations, and where the conduct was aimed at the public generally" (id.; see New York Univ. v. Continental Ins. Co., 87 N.Y.2d 308, 315–316, 639 N.Y.S.2d 283, 662 N.E.2d 763; Rocanova v. Equitable Life Assur. Socy. of U.S., 83 N.Y.2d 603, 612, 612 N.Y.S.2d 339, 634 N.E.2d 940). Moreover, punitive damages are available where the conduct associated with the breach of contract is first actionable as an independent tort for which compensatory damages are ordinarily available, and is sufficiently egregious to warrant the additional imposition of exemplary damages. ³⁰²³

The limitation of an award for punitive damages to conduct directed at the general public applies only in breach of contract cases, not in tort cases for breach of fiduciary duty.³⁰²⁴

Damages are called punitive, or exemplary, when they are assessed by way of punishment to the wrongdoer and example to others, and are not measured by the pecuniary loss or injury of the plaintiff as compensation.³⁰²⁵

Punitive damages is a sanction reserved to the State, a public policy of such magnitude as to call for judicial intrusion to prevent its contravention. Enforcement of an award of punitive damages as a purely private remedy would violate strong public policy.³⁰²⁶ The courts of this State have been so adamant that punitive damages are a social exemplary remedy, and not a private compensatory remedy, that the imposition of such damages for private purposes has been held to violate public policy.³⁰²⁷

It has always been held that punitive damages are not available for mere breach of contract, for in such a case only a private wrong, and not a public right, is involved—punitive damages is a social exemplary remedy, not a private compensatory remedy.³⁰²⁸ A private party seeking to recover punitive damages must not only demonstrate egregious tortious conduct that caused the aggrievement but also that such conduct was part of a pattern of similar conduct directed at the public generally,³⁰²⁹ bearing in mind that the conduct associated with the breach of contract is first actionable as an independent tort for which compensatory damages are ordinarily available.³⁰³⁰

It is not the form of the action that gives the right to give punitory damages, but the moral culpability of the defendant.³⁰³¹ Evidence that the defendant engaged in conduct which rises to the high level of moral culpability is necessary to support an award of punitive damages.³⁰³² Punitive or exemplary damages are allowed only in cases where the wrong complained of is morally culpable, or is actuated by evil and reprehensible motives, not only to punish the defendant but to deter him, as well as others who might otherwise be so prompted, from indulging in similar conduct in the future.³⁰³³ Subjecting a wrongdoer to punitive damages serves to deter future reprehensible conduct. Hence the term "exemplary damages" is a synonym for punitive damages.³⁰³⁴

Liquidated damages may not be a means of compelling performance.³⁰³⁵ No rule of law forbids parties from agreeing between themselves with respect to the anticipatory damages, which shall be occasioned by the failure to complete the contract within the time specified.³⁰³⁶ Although contracting parties may agree between themselves as to the amount of damages to be paid upon breach rather than leaving that amount to the calculation of a court or jury, however, the parties' designation as to whether the amount is a penalty or liquidated damages is not controlling.³⁰³⁷ In interpreting a provision fixing damages, it is not material whether the parties themselves have chosen to call the provision one for "liquidated damages" or have styled it as a penalty. Such an approach would put too much faith in form and too little in substance. Similarly, the agreement should be interpreted as of the date of its making and not as of the date of its breach.³⁰³⁸

Clauses purporting to require the payment of liquidated damages must be carefully drafted to avoid being characterized as penalties. Courts have struggled hard against the apparent intention of the parties in order to relieve the one in default from an improvident bargain.³⁰³⁹ When a clause is rejected as being a penalty, recovery is limited to actual damages proven.³⁰⁴⁰ Whether contractual provision "represents an enforceable liquidation of damages or an unenforceable penalty is a question of law, giving due consideration to the nature of the contract and the circumstances."³⁰⁴¹ A court must consider the nature of the circumstances and the time it was entered into.³⁰⁴²

The party seeking to avoid liquidated damages has the burden to prove that the stated liquidated damages are a penalty.³⁰⁴³ The challenging party must demonstrate either that damages flowing from the breach were readily ascertainable at the time entered into the agreement, or that payment for the breach is conspicuously disproportionate to these foreseeable losses.³⁰⁴⁴

A provision which requires, in the event of contractual breach, the payment of a...