When drafting or negotiating a contract, it may be tempting to include a fixed amount to be paid if the other party breaches the contract. This type of provision is called a liquidated damages clause.
Liquidated damages clauses are enforceable in Georgia if:
(1) the injury caused by the breach is difficult or impossible to estimate at the time of contracting;
(2) the parties intended to provide for damages rather than set a penalty for a breach; and
(3) the set amount of damages is a reasonable pre-estimate of the probable loss.
The test is conjunctive, so all three elements are necessary to have an enforceable liquidated damages clause. Lack of evidence as to any element will cause the provision to be an unenforceable penalty.
First Element: Damages are Unascertainable at the Time of Contracting
Damages are typically considered to be difficult or impossible to estimate at the time of contracting when the substance of the contract is heavily dependent on market forces (like employment or real estate contracts) or the injury flowing from the breach is lost profits.
However, if the damages are unknowable at the time of contracting, but it is known at the time of contracting that the damages would be easily ascertainable at the time of breach, then the first element is not satisfied.
In J.P. Carey Enterprises, Inc. v. Cuentas, Inc., the Georgia Court of Appeals held that damages for the untimely delivery of stock—which price changes daily—are not difficult to estimate. It noted the damages for that breach are easily calculable as the price of the stock on the date the stock should have been delivered.
Second Element: The Provision is Not Intended To Be a Penalty
Next, the provision must not seek to penalize the breaching party. To determine whether the provision is a penalty, the court considers the effect of the provision and if it is reasonable; to do this, it will look first to the language of the contract.
For example, if the contract refers to the sum sought as “liquidated damages,” the scale tips in favor of enforceability. The court can also consider how the parties discuss the provision to determine their intention. If the parties refer to it as a penalty, that counts against enforceability.
Third Element: The Provision Reasonably Estimates Probable Loss
This element is the most ripe for litigation. The liquidated damages amount must be a reasonable pre-estimate of the probable loss. To be a reasonable pre-estimate of probable loss, the provision cannot have a deterrent effect; a deterrent is considered a penalty. Caincare, Inc. v. Ellison, 272 Ga. App. 190, 193 (2005).
A reasonable pre-estimate of probable loss also does not need to be a fixed digit. Georgia law allows the contract to use a formula to calculate the numerical amount of liquidated damages, so long as the formula reasonably approximates probable loss. See Crown Series at 529–30.
The touchstone question of the third element “is whether the parties employed a reasonable method under the circumstances to arrive at a sum that reasonably approximates probable loss.” Mariner Health Care Management at 876. However, in Georgia, only actual damages can be recovered from a breach of contract.
Actual damages in a breach of contract are measured by the injury to the non-breaching party; punitive damages, exemplary damages, or disgorgement, for example, are not “actual damages.” An enforceable liquidated damages provision, then, must reasonably approximate the injury to the non-breaching party. SIS, LLC v. Stoneridge Software, Inc., 2023 WL 164067, *5 (11th Cir. 2023).
In SIS, the “liquidated damages” provision set as “liquidated” damages the amount of the breaching party’s profit directly or indirectly traceable to the breach. Therefore, the provision did not reasonably approximate the plaintiff’s probable loss (which must be measured by its own injury) and was not enforceable.
The SIS court explained that liquidated damages provisions which use formulas that reasonably approximate probable loss had three common elements:
* Time limitations for the length of the contract
* Discrete variables in the formula; and
* Contemplation of the payment had the breach not occurred. SIS at *6.
If you have questions about a liquidated damages clause in your contract, or want to draft an enforceable liquidated damages provision, please reach out to see if we can help.