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Read That Contract Carefully: Liquidated Damages Clauses Are Enforceable

Lerch, Early & Brewer's Legal Update

Read that contract very carefully before you sign on the dotted line! The Maryland Court of Appeals recently reiterated that the Maryland courts will enforce a well-written liquidated damages clause. The result is that if you are found to be in breach of contract you may well have to compensate the non-breaching party the amount set forth in the liquidated damages clause.

Liquidated damages are a specific sum agreed upon by the parties at the time that they enter into a contract, which is to be paid to compensate the non-breaching party for injuries in the event of a breach of that contract. Liquidated damages clauses are frequently found in real estate contracts, as well as in other types of agreements.

The Maryland Court of Appeals recently reviewed the law of liquidated damages in its decision of Barrie School v. Patch, 401 Md. 497 (2007). In the Barrie School decision, the Court held that a valid liquidated damage provision is enforceable. To be valid, a liquidated damages clause must satisfy two primary requirements: first, the clause must provide a fair estimate of potential damages at the time the parties entered into the contract, and second, the damages must have been incapable of estimation, or very difficult to estimate, at the time the parties entered into the contract. A clause purporting to provide for liquidated damages will be deemed to be invalid as a penalty where the amount agreed upon is grossly excessive and out of all proportion to the damages that might reasonably have been expected to result from the breach of the contract. If there is doubt whether the contract provides for liquidated damages or a penalty, the Maryland courts will construe the provision as a penalty. The measuring date for determining whether the clause provides a fair estimate of the potential damages is at the time the parties entered into the contract and not at the time of the actual losses resulting from the contract breach.

It was likely that the legal fees incurred by the parties in the Barrie School case were greater than the actual amount in dispute between the parties. The facts in the case were as follows: The Patches entered into a re-enrollment agreement for their daughter with the Barrie School which provided for a $1,000 non-refundable deposit and payment of the remaining balance of $13,490 in two installments. The agreement contained an escape clause that allowed parents the unilateral right to cancel the contract provided that the head of the School received written notice by May 31, 2004. If parents did not meet the May 31, 2004 deadline, they were obligated to pay the full tuition.

The Patches did not cancel the agreement until sometime after May 31, 2004 when they sent a non-conforming cancellation notice to the School – thereafter refusing to pay the balance of the tuition. The School sued in the District Court of Maryland. The Court found that there was a valid contract – including a valid liquidated damages clause. However, the trial judge determined that the School “...did absolutely nothing whatsoever to try to fill the space for this child ...” granting a verdict in favor of the Patches. The Barrie School appealed to the Circuit Court, which agreed with the District Court, issuing a written opinion holding that even though the liquidated damages clause was valid and not a penalty, the School had a duty to mitigate damages. The Court of Appeals agreed to hear the matter to address the question of whether there is a duty to mitigate damages in a breach of contract action where the trial court determines that the liquidated damages clause is valid and enforceable and not a penalty.

In its decision, the Court of Appeals took the opportunity to review the status of Maryland law concerning the enforceability of liquidated damages and reversed the holding of the lower courts that the non-breaching party had an obligation to mitigate its damages. The Court agreed with the Barrie School and enforced the liquidated damages clause, holding that the Patches had to pay the balance of the tuition fees notwithstanding that the Barrie School could have filled the vacant spot in the class with another child. As noted above, the Court determined that a validly written liquidated damages clause will be enforced – and, there is no obligation on the part of the non-breaching party to mitigate damages.

The moral of the story is that parties to a contract are well advised to carefully review the language of the contract, word by word, line by line. Ask questions of your attorney if you have any doubt about the meaning of contract language. If you enter into a contract that provides for liquidated damages to be paid on breach, it is likely that the courts will enforce that provision if it provides a fair estimate of the damages that the non-breaching party would suffer in the event of a breach.

Arnie Spevack represents individuals, businesses, lenders and borrowers in financings, closings, negotiations and in the courts. For more information about liquidated damages, contact Arnie at adspevack@lerchearly.com or (301) 657-0749.

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This content is for your information only and is not intended to constitute legal advice. Please consult your attorney before acting on any information contained here.

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