In-House Advisor

Hindsight Unfairness Is Not Going To Invalidate A Liquidated Damages Provision

November 20, 2023

   

I have written a number of blog posts on liquidated damages over the years, and one of the foundational points under Massachusetts law is that they will be enforceable if, but only if, at the time the contract is executed:

  1. It would be difficult to determine the damages that would accrue if the contemplated breach were to occur; and
  1. The liquidated amount designated in the contract is a reasonable estimate of the actual damages that a party would suffer if the breach were to occur.

In Cummings Properties v. Hines, the Supreme Judicial Court emphatically re-affirmed Massachusetts’s commitment to this “single look” doctrine.

In 2016, Cummings Properties entered into a five-year lease with MCO, Inc., and Darryl Hines, MCO’s sole officer and director, signed on as guarantor. The lease provided that if MCO defaulted, Cummings could terminate and the “entire balance of rent due . . . immediately [would] become due and payable as liquidated damages, since both parties agree that such amount is a reasonable estimate of the actual damages likely to result from such breach.”

Within only a few months of signing the lease, MCO defaulted on its payment obligations and was evicted. One year later, Cummings secured a four-year lease on the former MCO property with a third-party and then sued MCO and Hines to recover the liquidated damages. Cummings prevailed after a bench trial and was awarded just over $68,000 in liquidated damages.  Hines appealed, and the Appeals Court reversed, noting that because the liquidated damages clause did not account for the possibility that Cummings could re-let the premises, that clause amounted to an impermissible penalty. Cummings then took the matter to the Supreme Judicial Court, which reinstated the original decision by the trial court. In doing so, the SJC issued the following, clear rulings:

  • Contracts freely and fairly entered into will not be invalidated merely because “as here, the enforcement of the contract appears to produce harsh results.”
  • A liquidated damages provision will be enforced unless the party seeking to invalidate it can prove either that (1) damages resulting from the breach were easily ascertainable at the time the contract was signed, or (2) the liquidated amount was disproportionate to a reasonable estimate of what the actual damages likely would be as a result of the breach.
  • Simply asserting that a landlord like Cummings was “likely” to re-let the premises was not sufficient to show that making the full, unpaid rent the liquidated amount was unreasonable; there would have to be evidence supporting that assertion for there to be a finding that the liquidated amount was an invalid penalty.
  • When a contract includes a liquidated damages provision, Courts will not consider whether, at the time of breach, a plaintiff is able to mitigate its damages, as that would undermine the purpose of liquidated damages, i.e., to provide certainty at the time the contract is formed.

Thus, there are at least four key takeaways from Cummings Properties for in-house counsel. First, there may be no point in implementing a liquidated damages provision if the damages that would accrue from the contemplated breach would be obvious or easily ascertainable, as any such clause will be unenforceable. Second, ensure that the liquidated amount is a reasonable estimate of the likely damages. If you get greedy, that could invalidate the provision. Third, if a business partner breaches a contractual obligation and this implicates a liquidated damages provision, you should not hesitate to reasonably mitigate. Mitigating will not impair your ability to be awarded liquidated damages, and failing to mitigate could result in a needless opportunity cost. Finally, try to avoid having a company representative personally guaranty an obligation linked to a liquidated damages provision. While such a person may be able to make a case that they should be absolved of their obligation as guarantor because they are unsophisticated in such matters, as the trial judge in Cummings said: while Hines was not a “highly sophisticated business person,” he was “sufficiently sophisticated to be held to the provision of the contract he signed.”

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