Stipulated damages, super-strict liability, and mitigation in contract law.

• Author: Levmore, Saul

The remedy of expectancy damages in contract law is conventionally described as strict liability for breach. Parties sometimes stipulate damages in advance, and may agree that the damages they stipulate shall be the exclusive remedy for breach. They may do so because of their conviction that they can, even in advance, assess damages with greater accuracy than courts, and they may be wary of litigation costs associated with the postbreach determination of expectancy damages. This Article advances two claims. First, that the familiar expectation remedy is correctly understood to involve elements of fault. There is litigation over the question of fault with respect to the mitigation of damages. Stipulation, on the other hand, makes contract liability stricter because it takes the mitigation question away from courts. It allows less room for courts to modulate the remedy on the basis of the parties' relative fault. Stipulation often encourages mitigation by one party, but then, to make up for the strict liability character, the parties may stipulate in a more detailed manner to encourage bilateral mitigation. Mitigation considerations should change the way we think about many stipulated remedies. Second, while law is generally described as being suspicious of or even hostile to, stipulation--in large part because courts refuse to enforce "penalty" clauses--in fact, law encourages stipulation. It does this by sometimes declining to award expectancy damages, often in the very situations where stipulation seems sensible, and also by providing expectancy damages where the award of stipulated damages is regarded as a penalty. These two claims illuminate cases on such diverse matters as residential leases, construction contracts, product warranties, service contracts with liability waivers, and no-show customers and their service providers.

INTRODUCTION

The remedy of expectancy damages plays a central role in the conventional statement of American contract law. (1) Specific performance is a smaller but well recognized feature, and it is prominent in some subsets of contract law. (2) Both rules are usefully described as providing strict liability, though occasional academic campaigns draw attention to the ways in which fault permeates contract law. Fault is, of course, the foundational rule of American, if not all, tort law, and there it is strict liability that plays the supporting role.

The conventional statement also has something to say about stipulated damages, a term I use to include liquidation to an amount of money, as well as limitations on damages, scheduled damages, and other means of specifying the remedy for breach in advance and by bargain. It is that when these damages are "too high," measured either by actual damages expected at the time of contract formation or damages suffered by breach, courts will often disregard them as "penalty damages." (3) The disappointed party is then normally free to revert to collecting expectancy damages. (4) There is also a small literature on "underliquidated damages," and while such clauses might also be toxic to courts that hue to the expectancy-damage line of authority, they are more often acceptable. (5) Indeed, many waivers of liability can be understood as successfully stipulated low--if not rock bottom---damages.

This Article proceeds as follows. Part I locates stipulated damages in the firmament of fault, and shows that the remedy of stipulated damages outflanks that of expectancy damages on the strict liability spectrum. Contract law has been understood as deploying strict liability, but it is strict liability only to a point--because once the "duty to mitigate" is at issue, fault comes into play as courts consider the reasonableness of the post- and even the prebreach mitigation efforts. Through a variety of means, courts can modulate damages according to the parties' relative shortfalls in these efforts.6 In contrast, when the parties stipulate damages, they leave courts with less room in which to operate. With stipulation, the parties agree not only to take expectancy-damage determinations away from the court, but also to remove questions about mitigation. The remedy of expectancy damages thus constitutes a mixed system; there is, famously, strict liability with respect to breach, but then there is fault--a kind of comparative fault--with regard to mitigation. A stipulated-damage remedy can therefore be characterized as super-strict liability because it does not normally vary according to the fault of the parties, even when we take postbreach behavior into account. I explore this conception of contract remedies, and the idea of stipulated damages as super-strict liability and as a means of removing mitigation from the purview of the courts. In doing so, I illuminate classes of cases where courts are more or less inclined to accept stipulated damages.

Part II proceeds to a second, independent point as it reexamines the conventional wisdom that law is leery of, or, in effect, discourages, stipulated damages--if only by dismissing those deemed to be "penalty damage" clauses. I suggest that the opposite is true. In fact, the law may actually push contracting parties toward stipulation. For example, the expectancy-damage remedy is sometimes eviscerated by courts and, knowing this, parties will sometimes choose to stipulate damages in advance. Alternatively, they may simply prefer more strict liability. The real rule of contract remedies is probably that contracting parties should stipulate damages, at least when a postbreach assessment of damages would require something more than a comparison of market and contract prices. If this is right, then it follows that contract law, at least in this realm, seems to prefer super-strict liability. This reconception of contract remedies focuses attention on the strengths and weaknesses of the remedy of stipulated damages, especially as it pertains to mitigation.

1. STIPULATION, FAULT, AND MITIGATION

   1. The Effect of Stipulated Damages on the Nonbreaching Party

      Consider a case where the parties stipulate damages and custom, law, or perhaps even the contract itself leads to the conclusion that the stipulation is, or approaches the status of, an agreed-upon exclusive remedy. Common residential leases fit this description. A, an apartment building owner, might agree in July to rent premises to B for a one-year period, beginning September 1, at a rent of $2000 per month. Imagine that the lease agreement provides for a $1500 deposit in the event of damages beyond normal wear and tear, and also for a $2000 deposit to guarantee that the apartment will be held for the September occupancy. The latter money can be applied toward the last month's rent in August. In reality, the damage deposit is unlikely to be understood as stipulated damages, and to do so would create a series of problems. (7) But consider the situation in which the tenant, B, fails to materialize on September 1, or announces just before that date that he will break the lease. My interest here is in expectancy damages versus implicit stipulation, and in the parties' mitigation efforts. Imagine that A is immediately able to find another tenant, C, who agrees to pay the rent B had promised. As a result, A's damages are close to zero, and yet in most cases we expect A to retain the $2000 deposit, perhaps because it is hard for B to learn of the agreement with C, because A is seen as a kind of lost-volume seller, or because the deposit compensates A (in a manner courts might subtly recognize without articulating) for those other occasions when it is very difficult to locate a new tenant. This is the situation where A does not find a new tenant for some time, say ten months. In theory, A might then collect $20,000 from B, but these expectancy damages are rarely awarded. Parties to a residential lease have come to believe that if this part of the deposit is forfeited, it is the landlord's exclusive remedy. This belief or implied provision that this "deposit" amounts to stipulated damages, is like that which we attach to a storekeeper's sign declaring that there will be a $25 charge for a bounced check. The amount is understood to be the exclusive remedy available to the storekeeper, though it could turn out to be higher or lower than the actual damages, despite the fact that the Uniform Commercial Code insists that a contract be clear about an exclusive remedy. (8) In the case of both the breaching tenant and the bouncing check, the stipulated amount is apt to be regarded as a reasonably good (ex ante) estimate of expectancy damages. (9) In the case of the check, actual damages might include another bank's fee assessed against the storekeeper's account, as well as the loss that occurs when the storekeeper writes checks based on an incorrect assessment of his own bank balance--all of which could be reasonably thought to add up to, or to average, $25. Similarly, in the residential lease case, we might imagine that A, or even the typical landlord, averages one month to find a replacement tenant.

      This apparent treatment of the deposit as stipulated damages seems efficient in this context. A is in the superior position to find a replacement tenant. (10) The fixed damage amount gives A the right incentive to find C, and at the best possible price. (11) If instead the rule were that B retrieved the deposit in the event that A quickly found a replacement, A would have diminished incentive to expend resources on the search. An expectancy-damage rule runs a yet more serious risk that A will underinvest in the mitigation process. It is tempting to observe that custom has produced the more efficient rule. It is, after all, custom that has glorified the deposit to a point where it has become the automatic and exclusive remedy for breach, at least in most residential settings, despite the ostensible rule that the remedy of expectancy damages constitutes the default and...