Liquidated damages provisions
A liquidated damages provision is “[a] contractual provision that determines in advance the measure of damages if a party breaches the agreement.” Black’s Law Dictionary (8th ed. 2004), at 949-950. It might, for example, specify that the breaching party will pay to the nonbreaching party a fixed dollar amount in the event of a default. Or, it might take the form of a monetary cap on the breaching party’s damages.
A liquidated damages provision (which is also sometimes referred to as a stipulated damages provision) is appropriate when the non-breaching party’s actual damages would be difficult to estimate at the time of contracting. If the provision acts as a penalty, however, it will be unenforceable on public policy grounds, “[b]ecause the sole purpose of contract damages is to compensate the nonbreaching party for losses suffered as a result of the breach[.]” Lake Ridge Academy v. Carney (1993), 66 Ohio St.3d 376, 381, 613 N.E.2d 183. “Thus, when a stipulated damages provision is challenged, the court must step back and examine it in light of what the parties knew at the time the contract was formed and in light of an estimate of the actual damages caused by the breach. If the provision was reasonable at the time of formation and it bears a reasonable (not necessarily exact) relation to actual damages, the provision will be enforced.” 66 Ohio St.3d at 382. In Ohio, a liquidated damages provision will be upheld if it meets the following test:
Where the parties have agreed on the amount of damages, ascertained by estimation and adjustment, and have expressed this agreement in clear and unambiguous terms, the amount so fixed should be treated as liquidated damages and not as a penalty, if the damages would be (1) uncertain as to amount and difficult of proof, and if (2) the contract as a whole is not so manifestly unconscionable, unreasonable, and disproportionate in amount as to justify the conclusion that it does not express the true intention of the parties, and if (3) the contract is consistent with the conclusion that it was the intention of the parties that damages in the amount stated should follow the breach thereof.
Samson Sales, Inc. v. Honeywell, Inc.
(1984), 12 Ohio St.3d 27, 465 N.E.2d 392 (syllabus)
(holding that $50 cap on liability in burglar alarm
contract was unenforceable); see also Midamco,
L.P. v. Fashion Bug of Solon, Inc. (1996), 116
Ohio App.3d 854, 857-858, 689 N.E.2d 605 (collecting
cases in which liquidated damages provisions were
held unenforceable).
The party that seeks to benefit from a liquidated
damages provision should obviously avoid using the
term “penalty” to describe the damages. See,
e.g., Wright v. Bassinger, Mahoning
App. No. 01CA81, 2003-Ohio-2377 (holding that a
liquidated damages provision that specified a five
percent “penalty” was unenforceable). That party
should also be able to demonstrate that the parties
arrived at the method of calculating the amount of
the specified damages in a reasonable manner.
Id. at ¶20. It may also make sense to
provide affirmatively in the contract (to the extent
that circumstances permit) that actual damages would
be uncertain as to amount and difficult of proof,
that each party understands the liquidated damages
provision and has had access to counsel in connection
with reviewing and negotiating the terms of the
contract, that the provision is the result of arm’s
length negotiations, that the specified damages are
“proportionate in amount compared to the value of
services under” the contract (Republic Services
of Ohio Hauling, L.L.C. v. Pepper Pike Properties,
Inc., Cuyahoga App. No. 81525, 2003-Ohio-1348,
at ¶41) and “proportional to the anticipated ‘harm’
from the ‘breach’ of the contract” (Westbrock v.
W. Ohio Health Care Corp. (2000), 137 Ohio
App.3d 304, 323, 738 N.E.2d 799), that the parties
intend “to provide for liquidated damages in the
specified amount” (Young v. Int’l Bhd. of
Locomotive Engineers (1996), 114 Ohio App.3d
499, 509, 683 N.E.2d 420), and that the parties
intend the damages to serve merely as compensation,
and not as a penalty.
