BFV Perspectives, Georgia Business Disputes, | Jun 11, 2013

Liquidated Damages: How Not To Get Soaked

A liquidated damages clause is a contractual provision that specifies at the outset of a business relationship the monetary damages to be awarded in the event of a contractual breach. Such provisions can save time and money by establishing an issue that would otherwise be the subject of dispute and perhaps litigation. Critically, though, not every liquidated damages clause will be enforced by the courts.

Georgia courts consider three elements in determining the enforceability of a liquidated damages clause. First, the injury must be difficult or impossible to estimate accurately ahead of time. Second, liquidated damages must be compensatory rather than punitive in nature. Third, the agreed amount of damages must be a reasonable pre-estimate of the injury that would be suffered by the non-breaching party.

As to the first factor, lost profits are a classic example of a loss that is difficult or impossible to estimate accurately ahead of time. The more difficult it would be to determine what the non-terminating party would lose, the greater the chance that a liquidated damages penalty would be enforceable.

Second, courts consider whether a clause is intended to compensate the non-breaching party or to punish the breaching party. For example, in AFLAC, Inc. v. Williams, an in-house attorney had an agreement specifying that his employment would last for seven years and then automatically renew for another five-year term. In the event of early termination by the employer, the attorney was to receive 50% of his salary for the remainder of the entire twelve-year term. The Supreme Court of Georgia found this liquidated damages provision unenforceable, noting that the decision to award damages for up to eleven years to the attorney could not possibly have been based on the amount of time he would need to find new work.

On the other hand, in Mariner Health Care Management Co. v. Sovereign Healthcare, LLC, the Georgia Court of Appeals upheld a liquidated damages provisions that awarded the non-breaching party a rough approximation of its profit margin over the remainder of a five-year contract term where the company was able to show that it had budgeted for and relied upon the expectation of receiving that money.

The third factor, that the liquidated damages clause must represent a reasonable pre-estimate of the loss, may be the one over which businesspeople have the most control. During a contract’s negotiation, it behooves the parties to an agreement to “make good facts.” Because courts will look for any evidence that the parties, in negotiating the liquidated damages clause, considered the probable loss to the non-breaching party, the parties should document these considerations as much as possible. Where documentation shows an effort to make an reasonable estimate of the probable loss, courts are more likely to find that a liquidated damages clause is enforceable.

Though Georgia law on the enforceability of liquidated damages clauses is voluminous and very subtle, parties to a contract can save themselves much trouble by negotiating a well-thought-out liquidated damages clause and documenting their efforts. Doing so can greatly reduce the time and expense associated with establishing the damages related to a contractual breach.

BFV Perspectives, Georgia Business Disputes, | Jun 11, 2013