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Instructor Manoj Nair, Lawyer
"Construction Contract Management"
March 6th, 2023 @ 1000/10AM (New York Time)
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Volume 2023: Issue #2: Contract Hints & Legal Issues: February 2023
Understanding LIquidated Damages!
1. What are Liquidated Damages (LQDs)?
A liquidated damages clause specifies a predetermined amount of money that must be paid as damages for failure to perform under a contract. The amount of the liquidated damages is supposed to be the parties' best estimate at the time they sign the contract of the damages that would be caused by a breach. If a breach occurs and the liquidated damages clause is enforceable, the parties do not calculate the actual damages (i.e., how much money a party actually lost as a result of the breach). Instead, the breaching party pays the predetermined sum provided by the liquidated damages provision.
2. Liquidated Damages under California Law:
In California, the objective of a liquidated damages clause is to stipulate a pre-estimate of damages in order that the contracting parties may know with reasonable certainty the extent of liability in the event of breach. El Centro Mall, LLC v. Payless ShoeSource, Inc. (2009) 174 Cal.App.4th 58 [94 Cal.Rptr.3d 43] Liquidated damages are viable if it is established that at the formative stages of the contract it was mutually agreed that damages from a breach would be impracticable or extremely difficult to determine with certainty, and that the amount or formula stipulated by the parties represented a reasonable endeavor to ascertain what such damages might be. Vrgora v. Los Angeles Unified School Dist. (1984) 152 Cal.App.3d 1178 [200 Cal.Rptr. 130].
In California, facts must be pleaded and proved from which the court can say as a matter of law that the contract for liquidated damages is valid because from the nature of the case it would be impracticable or extremely difficult to fix the actual damage. Hence, the mere stipulations of the contract are insufficient for that purpose. Sunmaid Raisin Growers of California v. Paul A. Mosesian & Son (1928) 90 Cal.App. 1, 6 [265 P. 828, 830].
Liquidated damages clauses are presumed valid in California, with the burden of proof on the party seeking to invalidate a clause to show that it was unreasonable under the circumstances existing at the time of the contract.
3. Are LQDs’ clauses enforceable in Software Agreements? Yes.
4. Can the Uniform Commercial Code (U.C.C.) apply to Software Agreements? It all depends on the case.
In Gross v. Symantec Corp., No. C 12-00154 CRB (N.D. Cal. July 31, 2012)., Symantec argued that the California UCC "only covers the sale of goods, which excludes licenses for the use of intellectual property, like Symantec's software." Citing RRX Indus., Inc. v. Lab-Con, Inc., 772 F.2d 543, 546 (9th Cir. 1985), the court acknowledged that "[s]oftware transactions often straddle the line between goods and services, so courts look to the 'essence of the agreement' to determine how best to characterize the transaction." Because software varies depending on consumer needs being met, software contracts are analyzed on a case-by-case basis.
5. In a Software Agreement where will LQDs most likely be applicable?
When installing software and/or setting up a network (Project Deadlines); and in a Service Level Agreement (Ongoing Network Support). The SLA describes every service offered, under all possible circumstances, with the turnaround times included. Service definitions should include how the services are delivered, whether maintenance service is offered, what the hours of operation are, where dependencies exist, an outline of the processes and a list of all technology and applications used, and network uptime, if applicable.
6. A sample LQDs clause.
In the event of delay in [type of project] completion, the [performing party] shall pay liquidated damages to [the owner] in the amount of [dollar amount per day/week, etc.] [or] ["X" percent of the total contract price per day/week, etc.].
7. When are LQDs not awarded? When they are seen as penalties or punitive.
Whether provision in a contract is for liquidated damages or for a penalty, depends on intent of parties as evidenced by entire agreement, construed in light of circumstances under which it was made, and such intent is to be determined at time contract is entered into. Hanlon Drydock & Shipbuilding Co. v. G.W. McNear, Inc. (1924) 70 Cal.App. 204 [232 P. 1002].
A penalty clause is a contractual clause that imposes liquidated damages that are unreasonably high and represent a punishment for breach, rather than a reasonable forecast of damages for the harm that is caused by the breach, are referred to as penalty clauses. These clauses allow parties, at the time of contracting, to agree to their respective damages liability if they later breach. While liquidated damages clauses are generally enforceable, courts do not enforce penalty clauses.
The Second Restatement of Contracts, Section 356 states:
“(1) Damages for breach by either party may be liquidated in the agreement but only at an amount that is reasonable in the light of the anticipated or actual loss caused by the breach and the difficulties of proof of loss. A term fixing unreasonably large, liquidated damages is unenforceable on grounds of public policy as a penalty.
(2) A term in a bond providing for an amount of money as a penalty for non-occurrence of the condition of the bond is unenforceable on grounds of public policy to the extent that the amount exceeds the loss caused by such non-occurrence.”
[Last updated in July of 2020 by the Wex Definitions Team]
8. How To Avoid Paying Out LQDs?
Realistic scheduling and thorough pre-planning are the first steps to avoiding liquidated damages payouts. Efficient processes and smooth workflows facilitated by lots of communication and data sharing will help keep a project running as possible.
9. Can LQDs be challenged?
Even though the parties may agree at the time of contracting as to their measure of damages, the validity a liquidated damages clause may still be challenged in a lawsuit, and such challenges can look an awful lot like proving actual damages—and can be just as contentious.
10. Will a buyer or seller want a LDQs clause in the agreement? Correct, buyer.