Sharp Thinking

No. 110    Perspectives on Developments in the Law from The Sharp Law Firm, P.C.        March 2014

Appellate Court Issues Valuable Primer On Liquidated Damages Clauses in Contracts

            By John T. Hundley, jhundley@lotsharp.com, 618-242-0246

       An Appellate Court panel in Chicago has issued a valuable primer on when liquidated damages clauses will be deemed permissible and impermissible under Illinois law.

       In GK Dev., Inc. v. Iowa Malls Fin. Corp., 2013 IL App (1st) 112802, plaintiff purchased four shopping centers from sellers, one of which locations being subject to a pending long-term lease with a new anchor tenant.  They agreed that at closing $4.3 million would be put in escrow and “forfeited” by sellers if the contemplated lease and all required governmental permits were not obtained by a date certain.  The permits in fact were not completed until 91 days late.  The trial court upheld the forfeiture provision as a permissible liquidated damages clause. 

       The Appellate Court reversed.  The panel started with the general rule that “[d]amages for breach by either party may be liquidated in the agreement but only at an amount that is reasonable in the light of the anticipated or actual loss caused by the breach and the difficulties of proof of loss.  A term fixing unreasonably large liquidated damages is unenforceable on grounds of public policy as a penalty.”  It noted that the “purpose of damages is to place the nonbreaching party in a position that he or she would have been in had the contract been performed, not to provide the nonbreaching party with a windfall recovery,” and that “[i]in doubtful cases, we are inclined to construe the stipulated sum as a pen

       Construing prior case law, the panel said courts generally will find a liquidated damages provision valid when three factors are satisfied:  “(1) the parties intended to agree in advance to the settlement of damages that might arise from the breach; (2) the amount of liquidated damages was reasonable at the time of contracting, bearing some relation to the damages which might be sustained, and (3) actual damages would be uncertain in amount and difficult to prove.” 

       The court said the first prong was failed because all the evidence was that the $4.3 million provision was based on a possible total loss of the contemplated lease and there was “no evidence that the parties contemplated damages for a minor delay in obtaining permits. . . . The mere negotiation and insertion of the liquidated damages clause does not show that the parties intended to agree in advance that $4.3 million would serve as liquidated damages for a 91-day delay (or any delay) in obtaining permits.”

       The panel also found that the clause failed the law’s second test:  “while the $4.3 million in liquidated damages might have been reasonable in the event that the . . . lease never occurred, it was not reasonable for a 91-day delay in securing government permits.”

       The court said it acted also because courts “invalidate[] liquidated damages clauses where they amount to a windfall for one of the parties” and “where the purpose of the clause is to punish nonperformance rather than estimate damages.”  Noting that the 91-day delay did not result in anything approaching $4.3 million in damages, the court said that “[a]lthough liquidated damages may at times exceed the amount of actual damages,” a clause providing “unreasonably large liquidated damages is unenforceable on grounds of public policy as a penalty.”

       It said these rules invalidated the clause at issue notwithstanding the sophisticated nature of the parties to the transaction.  It distinguished cases upholding clauses that stipulated a formula for determining damages depending on how long the breach lasted.  “When a contract specifies a single sum in damages for any and all breaches even though it is apparent that all are not of the same gravity, the specification is not a reasonable effort to estimate damages; and when in addition the fixed sum greatly exceeds the actual damages likely to be inflicted by a minor beach, its character as a penalty becomes unmistakable.” 

Court Upholds Exculpatory Clause In Fitness Contract

       A release clause exculpating a defendant from its own negligence in future occurrences is enforceable if it puts the prospective plaintiff “on notice of the range of dangers for which he (or she) assumes the risk of injury, enabling him (or her) to minimize the risk by exercising a greater degree of caution,” a panel of the Appellate Court in Chicago has held.

       Cox v. US Fitness, LLC, 2013 IL App (1st) 122442, involved a fitness club member injured through defendant’s negligent fitness instruction and use of equipment after she signed an agreement that she “assume[d] all risks of personal injury” associated with, among other things, equipment and fitness advisory services.

       Rejecting arguments that the exculpatory clauses should not be enforced, the court said Illinois “permits parties to contract away liability for their own negligence,” though such clauses are “strictly construed”.  The language “should be clear, explicit and unequivocal,” the court said.  The precise occurrence that resulted in the injury “need not have been contemplated by the parties at the time of contracting. . . . The injury must only fall within the scope of possible dangers ordinarily accompanying the activity and, therefore, reasonably contemplated by the parties.”  The court said the clause at issue met those tests. 

 

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