ACREL News & Notes September 2019 Tennessee Law on Liquidated in Real Purchase and Sale Agreements

Kenneth (Pete) Ezell Jr., Baker, Donelson, Bearman, Caldwell, & Berkowitz, PC, Nashville, TN Jordan A. Ferrell, University of Tennessee College of Law, Class of 2020, Nashville, TN

It is common for parties to commercial real estate purchase and sale agreements ("PSA") to include a liquidated damages provision, usually for a breach of the PSA by the buyer. There are not very many Tennessee cases addressing the enforceability and effect of liquidated damages provisions in PSA's and of the few that do, some are quite old. Most of the recent Tennessee cases addressing liquidated damages involved employment agreements. This article will explore a variety of issues that are or could be presented by liquidated damages provisions in PSA's.

This article is submitted as part of the ongoing project of the American College of Real Estate Lawyers Acquisitions Committee to answer the following 13 questions related to the liquidated damages remedy in PSA's under the law of various states. Here are the answers to those questions as discerned through research of Tennessee law.

I. May The Seller Choose Instead Of Liquidated Damages (So That Liquidated Damages Are Not An Exclusive Remedy)?

Yes, in Tennessee, the Tennessee Supreme Court does not necessarily interpret a liquidated damages provision as the exclusive remedy for the breach of a , and the existence of a liquidated damages provision "[does] not preclude the complainant from seeking a specific performance." Leeper v. Morelock, 76 S.W.2d 335, 337 (Tenn. 1934). A purchaser may sue for specific performance instead of pursuing liquidated damages. The Court's intent is to prevent an obligor from "reliev[ing] himself from the duty to convey" and subverting specific performance by paying the liquidated damages. Id. (citing Kettering v. Eastlack, 107 N.W. 177, 178 (Iowa 1906)). In Kettering, the court found that “[w]here it is apparent that the intention was that the obligor convey, and the provision for damages or penalty is simply a means of securing conveyance, the obligor cannot relieve himself from the duty to convey, which will enforce, by tendering payment of the penalty or damages.” Kettering, 107 N.W. at 178. It is worth noting that the PSA in Leeper did not have a provision stating that liquidated damages were the seller's sole and exclusive remedy, at law or in equity. Many present-day PSA's contain such a provision.

In Loveday v. Barnes, 1992 Tenn. App. LEXIS 539, 1992 WL 136176, the Court of Appeals noted that PSA's may limit a party's remedies to recovery of liquidated damages, if it is evident that such a limitation was the intent of the parties.

II. May The Seller Choose Actual Damages Instead Of Liquidated Damages (So That Liquidated Damages Are Not An Exclusive Damage Remedy)?

It is likely that parties can pursue other remedies outside of liquidated damages, including actual damages. The language of the contract will be critical. In G.H. Swope Bldg. Corp. v.

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ACREL News & Notes September 2019 Horton, 338 S.W.2d 566, 567 (Tenn. 1960), a contract clause contained the following, “[T]he owner may at his option, (1) retain the sum of money deposited which I agree shall constitute liquidated damages for my failure or refusal to abide by the terms of the offer, or (2) proceed to enforce his legal rights, if any.” To the extent that a complainant has received a deposit and the contract provides for the pursuit of any other legal rights pursuant to a breach, outside of liquidated damages, the complainant shall have the choice of retaining “the deposit as ‘liquidated damages’ even though he be not damaged, or he may return the deposit to the proposed buyer and ‘proceed to enforce his legal rights, if any.” Id. at 568.

In Loveday, however, the PSA provided that the earnest money deposit may [emphasis added] be forfeited as liquidated damages. The Court focused on the permissive nature of that provision in holding that the seller could recover actual damages in addition to liquidated damages. It was important in Loveday that the contract was modified by the parties due to changed circumstances (buyer divorcing and moved into the seller's property prior to closing), such that the parties could not have reasonably estimated the full extent of the seller's damages at the time of execution of the PSA. Loveday v. Barnes, 1992 Tenn. App. LEXIS 539, 1992 WL 136176.

III. If The Seller May Choose Liquidated Damages Or Actual Damages, May It Have Both?

No, the seller may not have both. As mentioned in II, the specific language of the contract will be critical. The specific language proscribes any other construction and the complainant is “entitled to but one of the two alternatives.” G.H. Swope Bldg. Corp., 338 S.W.2d at 568. The Court looks to Thompson v. Exchange Building Company, 8 S.W.2d 489 (Tenn. 1928) for precedent. In that case, the Court held that a breach “merely gives the seller the choice of enforcing his full rights against the purchaser, or claiming the amount stipulated as liquidated damages,” and the complainant's election to retain the deposit as liquidated damages “conclusively estopped [the complainant] from resorting to any other remedy.” Thompson, 8 S.W.2d at 492.

IV. If The Seller May Choose Liquidated Damages Or Actual Damages, But Not Both, When Must It Decide?

As discussed in III, the seller must decide which remedy he seeks to pursue before he actually retains the deposit as liquidated damages. The action of retaining the deposit as liquidated damages “conclusively estopped [the complainant from resorting to any other remedy.” G.H. Swope Bldg. Corp., 338 S.W.2d at 568.

V. Is There An Applicable Statute Addressing Liquidated Damages Clauses?

Tennessee does not have a statute that addresses liquidated damages provisions.

VI. What Is The Test For A Valid Liquidated Damages Clause?

The Tennessee Supreme Court established a three-part test to determine the validity of a liquidated damages clause. In order to be valid: 1) the parties must intend that it is liquidated 2

ACREL News & Notes September 2019 damages and not a penalty; 2) it must be a reasonable estimate of potential damages at the time of contract formation; 3) actual damages must be indeterminable or difficult to measure. Guiliano v. Cleo, Inc., 995 S.W.2d 88, 100-101 (Tenn. 1999). Vanderbilt Univ. v. DiNardo potentially added a fourth element, that liquidated damages cannot be grossly disproportionate to the actual damages. 174 F.3d 751 (6th Cir. 1999) [But see discussion in VIII below].

VII. Who Has The Burden Of Proof?

This issue is not free from doubt in Tennessee. On the one hand, the Tennessee Supreme Court has stated that “when there is doubt whether a provision is intended to be liquidated damages or a penalty, the court must construe it as a penalty.” Beasley v. Horrell, 864 S.W.2d 45, 48 (Tenn. Ct. App. 1993), overruled on other grounds by Guiliano v. Cleo, Inc. (citing Testerman v. Home Beneficial Life Ins. Co., 524 S.W.2d 664, 668 (Tenn.App.1974)). Also, in Eatherly Contruction Company v. HTI Memorial Hospital, 2005 WL 2217078 (Tenn. Ct. App. Sept. 12, 2005), without citing Beasley, the Court of Appeals ruled that the party seeking to enforce a liquidated damages clause had the burden to establish that the liquidated sum was a reasonable estimate of potential damages.

On the other hand, the Tennessee Court of Appeals has also held that the burden of proving that a liquidated damages provision is a penalty is on the party seeking to avoid the clause. Unifirst Corp. v. Lane, No. M200000357COAR3CV, 2001 WL 8791, at *4 (Tenn. Ct. App. Jan.4, 2001) (citing Farmers Export Co. v. M/V Georgis Prois, 799 F.2d 159 (5th Cir.1986)). The Unifirst decision also did not cite Beasley.

VIII. As Of When Is "Reasonableness" Tested?

The reasonableness of a liquidated damages provision is to be be tested at the time of contract formation, which is considered a prospective approach. Guiliano, 995 S.W.2d at 100. In Guiliano, the Tennessee Supreme Court selected the prospective approach and expressly rejected the Court of Appeals' retrospective approach because it defeats one of the intended purposes of including a liquidated damages clause in a contract: to avoid litigating actual damages that are uncertain and difficult to prove. Under the Court of Appeals' retrospective approach, "the parties are allowed to fully litigate actual damages following a . If the non-breaching party fails to prove actual damages, then he or she is barred from recovering the liquidated sum originally agreed upon in the contract." Id. (Court held that "it is unfair to require the non-breaching party to prove actual damages in cases where the parties agreed in advance to a liquidated damages provision" . . . and "ignores the original intentions of the parties and defeats the purposes of stipulating in advance to potential damages."). Guiliano, 995 S.W.2d at 100.

Since Guiliano was decided by the Tennessee Supreme Court after the U.S. Court of Appeals decision in Vanderbilt Univ. v. DiNardo, the "grossly disproportionate" standard enunciated in Vanderbilt case may not be applicable, since it requires a retrospective analysis of the amount of liquidated damages.

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ACREL News & Notes September 2019 IX. What Percentage Of The Purchase Price Is Likely Acceptable As Liquidated Damages?

There is no bright line rule in Tennessee on this point. As discussed in VIII above, the "reasonableness of a provision for liquidated damages is to be determined prospectively, i.e. at the time the parties contracted, and not retrospectively by [the court]." Kendrick v. Alexander, 844 S.W.2d 187, 191 (Tenn. Ct. App. 1992). Courts have considered this percentage in determining the reasonableness of the liquidated damages. The Kendrick court held that 12% liquidated damages relative to the total purchase price was reasonable under the terms of the contact. Id. (court stated, "The amount of liquidated damages equals only twelve percent (12%) of the purchase price . . . we find the fee to be reasonable in relation to the terms of the contract . . . The fact that [the defendant] ultimately sold the property for $550,000.00 is not determinative, as the reasonableness of a provision for liquidated damages is to be determined prospectively.).

In Covington v. Robinson, 723 S.W.2d 643, 647 (Tenn. Ct. App. 1986), the court upheld a liquidated damages provision that represented only 5% of the total purchase price, which was viewed as neither unconscionable nor disproportionate to the prospective actual damages.

On the other hand, in Harmon v. Eggers, 699 S.W.2d 159, 164 (Tenn. Ct. App. 1985), overruled on other grounds by Guiliano v. Cleo, Inc., the court held that the breaching party's loss of over 50% of the total purchase price as liquidated damages was equivalent to a forfeiture/penalty and, therefore, violated public policy.

Kimbrough & Co. v. Schmitt (939 S.W.2d 105 (Tenn. Ct. App. 1996)) involved a land sale contract, where the buyer was to make installment payments of the purchase price of real property over time and then receive a deed after payment in full. The contract provided for liquidated damages in the amount of 15% of the purchase price, reduced by 1% each year that the buyer made installment payments. The Court held that this amount was not a reasonable forecast of the seller's damages and held the liquidated damages provision to be unenforceable.

X. Are Actual Damages Relevant For Liquidated Damages, And In Particular, Will Liquidated Damages Be Allowed When There Are No Actual Damages?

Given that Tennessee has adopted the "prospective" approach to review of liquidated damages provisions, Tennessee courts should allow recovery of liquidated damages even where there are no actual damages, as long as it was not known at the time of contract formation that there would be no actual damages. This assumes all of the elements discussed in VI above are met. The Guiliano court held, "The extent of actual damages has no bearing on the appellant's recovery of liquidated damages," that the parties' originals intentions were properly reflected, and that though“‘[t]he bargain may be an unfortunate one for the delinquent party, ... it is not the duty of courts of to relieve parties from the consequences of their own improvidence.’” 995 S.W.2d at 101 (citing Watson v. Ingram, 124 Wash.2d 845, 881 P.2d 247, 250 (Wash. 1994) (quoting Dwinel v. Brown, 54 Me. 468, 470 (Me. 1867)).

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ACREL News & Notes September 2019 XI. Is Mitigation Relevant For Liquidated Damages?

Mitigation is not necessary or relevant for liquidated damages because mitigation would offset actual damages, and as discussed in X above, actual damages are irrelevant. In Guiliano v. Cleo, Inc., following the employee's termination that triggered the employer's obligation to pay liquidated damages to the employee, the employee proceeded to secure a job with a higher salary. The employer argued that the higher salary eliminated the possibility of actual damages, and that any liquidated damages would subsequently serve exclusively as an unlawful penalty. Id. The court disagreed with the employer, holding that the employee's subsequent good fortune in employment and lack of actual damages had "no bearing on the appellant's recovery of liquidated damages."

XII. Is A "Shotgun" Liquidated Damages Clause Enforceable?

A "shotgun" liquidated damages clause is likely unenforceable in Tennessee. In City of Nashville v. Nashville Traction Co, 142 Tenn. 475 (1920), the Tennessee Supreme Court refused to enforce payment to the City of Nashville of a $200,000 performance bond posted by a private company that had been given a franchise to construct and operate street car lines. The company did not complete construction, although it had spent about $165,000 on construction. In so ruling, the Court stated:

The courts almost uniformly hold where a contract contains a number of stipulations of varying degrees of importance and a single sum is made payable for any breach, applicable alike to important and unimportant covenants, it will be treated as a penalty rather than liquidated damages, no matter what name is given it by the parties. Cases to this effect are too numerous to be cited. They will be found collected in 17 C. J. p. 953; 8 R. C. L. p. 571; note, Ann. Cas. 1912C, 1024; note, L. R. A. 1915E, 373; note, 108 Am. St. Rep. 56; Sutherland on Damages, § 294; Pomeroy, Eq. Juris. § 441.

The Court favorably cited the Wisconsin Supreme Court in its ruling:

". . . and we quite agree with the Supreme Court of Wisconsin that where a bond is given to secure various covenants, conditions, and agreements of the principal contract, some of them trivial, a “penal sum” named cannot be treated as liquidated damages for some covenants and a penalty only as to others. Madison v. American Sanitary Engineering Co. [118 Wis. 480, 95 N.W. 1097]."

The Tennessee Court of Appeals cited City of Nashville in a case where the amount stipulated as liquidated damages (although not called that in the decision) was not a reasonable forecast of the actual damages. The plaintiff, who was in a cash pinch, sold two commercial buildings to the defendant and then leased them back. The defendant delivered a $100,000 note as partial payment of the purchase price. The note provided that if the plaintiff missed any lease payments, then the note would be cancelled. The plaintiff did miss some lease payments, but the defendant had a right of setoff in the note, so it had an . The Court held that the note cancellation provision was penal in nature and therefor unenforceable. Beasley v. Horrell, 864 S.W. 2d 45 (1993) [Reversed on other grounds]. 5

ACREL News & Notes September 2019 XIII. Does a Liquidated Damages Clause Preclude the Recovery of Attorneys’ Fees by the Seller?

There is no relevant case law in Tennessee on this issue, but it is likely that Tennessee courts could award attorney's fees in addition to liquidated damages, in their discretion, provided that the PSA contained an attorney's fee provision. Any fees awarded would have to be deemed "reasonable" and Tennessee applies a multi-factor test based on the Rule 1.5 of the Rules of Professional Conduct. Mize v. Consulo, No. M2011-00455-COA-R3CV, 2011 WL 6152980, at *7 (Tenn. Ct. App. Dec. 8, 2011).

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