Litigation 4 Tips for a Better Liquidated Clause This article was originally published in the June 25, 2013 edition of Corporate Counsel. by Eric Fishman and Anne Lefever

This is another installment of The Sanity Clause, a regular column by Eric Fishman examining issues faced by in-house counsel.

If not carefully drafted, a liquidated lightning rod for litigation, frequently damages clause can invite as much striking the breaching party as litigation as it eliminates. Consider excessive when a default later occurs. a typical clause in which the parties stipulate to damages in the event of There are four types of challenges Eric Fishman delayed delivery: commonly raised to such clauses, Litigation which give rise to four drafting New York office “If Seller breaches its obligation techniques that should be considered +1.212.858.1745 to deliver goods in accordance when negotiating the terms of such a [email protected] with the schedule provided for liquidated damages provision: in this contract, Buyer shall have the option to recover $x 1. Use caution in drafting liquidated per day for each day of delay as damages clauses that are optional liquidated damages.” in nature

Parties enter into such stipulations to In litigation, the first thing that eliminate disputes over the amount a breaching party would likely of damages, an expensive aspect of challenge with respect to the above- litigation often involving significant stated liquidated damages clause is Anne Lefever discovery and the retention of experts. the option of the buyer to resort to Litigation it. While a few courts have ruled that New York office Although not as well-appreciated, a sophisticated parties may agree to +1.212.858.1267 liquidated damages clause can also optional liquidated damages clauses, [email protected] eliminate disputes about mitigation. see, e.g., Avery v. Hughes, 661 F.3d 690 As a general rule, a breaching party (1st Cir. 2011), the majority rule is that cannot seek to reduce or avoid the such clauses are unenforceable. Were payment of liquidated damages the rule otherwise, the clause would by claiming that the aggrieved be “invoked only as a penalty when party failed to mitigate; that would the liquidated damages exceeded undermine the predictability that the actual damages.” Grossinger such clauses are supposed to ensure. Motorcorp., Inc. v. Amterican Nat’l See 24 Williston on §65.31 Bank & Trust Co., 180 Ill. Dec. 824 (Ill. (4th ed. 2013). App. 1992); see also Stock Shop, Inc. v. Bozell and Jacobs, Inc., 126 Misc. 2d While plainly of value, liquidated 95 (N.Y.Sup.Ct. 1984); J. M. Perillo, damages clauses also serve as a sort of Calamari and Perillo on Contracts

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§14-32 (6th ed. 2009) (optional As these damages outcomes can be inherently difficult insofar as delay liquidated damages provisions dramatically different, careful consid- may impact the Buyer’s reputation “have been struck down as they do eration should be given at the time of or require the Buyer to provide not involve a reasonable attempt drafting to specify just what types of non-monetary concessions (such definitively to estimate the loss”). As losses are and are not being liquidated. as a loaner widget) to its own a general rule, therefore, avoid using To address the situations just customer, and further stipulate optional liquidated damages clauses. mentioned, for example, the parties that the agreed upon sum is not a may wish to include a provision along penalty, but rather a reasonable If, however, drafters are in a juris- the following lines: measure of damages, based upon diction where this issue has not the parties’ experience in the been squarely addressed and they “The liquidated damages clause widget industry and given the nonetheless wish to include an herein is intended to reputa- nature of the losses that may result optional liquidated damages clause, tional and other losses suffered by from delay.” consider incorporating the following the Buyer in the event the Seller’s saving provision: delay does not cause the Buyer While such a provision does not to lose an existing resale of the guaranty the enforceability of the “In the event the liquidated widget. This liquidated damages clause, it will certainly undermine the damages clause set forth herein provision shall not apply in the aggrieved party’s ability to contend is found to be penal in nature event Seller’s delay causes Buyer to that the clause was not reasonable at because it gives the aggrieved lose a sale on an existing contract.” the time of contracting. party the option to invoke it, the parties agree that the liquidated 3. Incorporate the rationale for the 4. Give to specifying damages provision shall apply and clause into the clause itself the events intended to trigger the option shall be null and void.” the clause Liquidated damages clauses are 2. Specify the damages that the enforceable in most jurisdictions, The final area of common disagree- parties intend to liquidate provided that, at the time of ment over liquidated damages clauses contracting, (i) it was difficult concerns whether the conditions Parties often fail to give sufficient to quantify actual damages, and necessary to trigger the clause have consideration to the types of damages (ii) the agreed upon sum bears a been satisfied. This issue most often they intend to liquidate. For example, reasonable relationship to those arises in two situations. In the first, assume the seller in our hypothetical anticipated damages. the seller is technically on time, liquidated damages clause is a but the goods cannot be used for manufacturer of widgets and the As might be expected, in litigation, a other reasons—for example, due to buyer is a wholesaler. In one scenario, breaching party will often contend regulatory approvals that have not the manufacturer’s delay may cause that these conditions were not yet been received. A well-drafted the wholesaler to be late with respect satisfied, which raises an obvious (but delay liquidated damages clause will to its own downstream performance. often looked) drafting tip: Set forth specify whether it applies when delay Such a wholesaler may suffer some the rationale for the clause in the is caused by a third party (here, the reputational harm or even have to pay clause itself. regulator) rather than the seller. delay damages to its own customer (the retailer), but the downstream Thus, for example, the above-stated In the second situation, disputes arise transaction will nonetheless proceed. liquidated damages provision might over whether “concurrent delay” is By contrast, in another scenario, the be supplemented as follows: the type of delay for which the buyer manufacturer’s delay may cause the can invoke the clause. If, to continue wholesaler completely to lose its “The parties agree that quantifying with our example, a manufacturer resale to the retailer. losses arising from Seller’s delay is is delayed by a month because of a

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work stoppage, but the wholesaler also or delay caused by a third-party. caused concurrent delay by failing The parties further agree to provide specifications and other that this liquidated damages information needed by the manufac- provision shall not apply in turer during that same period, is there the event Seller’s delay causes compensable delay? While the law Buyer to lose a sale on an provides divergent answers to this existing contract.” issue in different jurisdictions, the loss itself can and, ideally, should be By (i) eliminating the optional nature allocated in the clause itself. of the clause, (ii) specifying the rationale for liquidating damages, (iii) Putting all of these lessons together, a identifying the types of losses to be more robust liquidated damages clause liquidated (and not to be liquidated), might read something like this: and (iv) clarifying the events that will (and will not) trigger the clause, “If Seller breaches its obligation drafters can significantly reduce the to deliver goods in accordance types of litigation that commonly with the schedule provided for attend liquidated damages clauses. in this contract, Seller shall pay Buyer $x per day for each Eric Fishman is a partner at Pillsbury day of delay as liquidated Winthrop Shaw Pittman, where he damages. The parties agree represents both industrial companies that quantifying losses arising and financial institutions in complex from Seller’s delay is inherently disputes arising out of purchase and difficult insofar as delay may sale agreements, procurement contracts, impact the Buyer’s reputation leveraged leases, credit default swaps, or require the Buyer to provide reinsurance contracts, and partnership non-monetary concessions and LLC operating agreements. These (such as a loaner widget) to cases also frequently involve fraud, its own customer, and further fiduciary breach, and equitable claims. stipulate that the agreed Anne Lefever is a senior associate at the upon sum is not a penalty, but firm whose practice focuses primarily on rather a reasonable measure complex commercial contract disputes, of damages, based upon the as well as white-collar defense. parties’ experience in the widget industry and given the nature of the losses that may result from delay. This provision shall [shall not] apply in the event of concurrent delay

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