When parties enter into a contract, they may choose to determine in advance how much money should be paid in the event one of the parties breaches the contract. That amount is identified in a liquidated damages provision. However, not every liquidated damages provisions is enforceable, even if the parties expressly agreed to it. In deciding whether to enforce a liquidated damages provision, Massachusetts courts consider two criteria: whether the actual damages would be difficult to ascertain, and whether the liquidated damages outlined in the contract are a reasonable forecast of the damages that could potentially result from a breach. If those two criteria are not met, the liquidated damages outlined in the contract will be deemed a penalty and the provision will not be enforceable.
A liquidated damages provision is presumed valid when negotiated by two sophisticated parties. The party challenging the validity of the provision bears the burden of proof. The validity of the provision is a matter of law, meaning that that issue can be addressed early in the litigation by the filing of a dispositive motion.
In Mittas Early Learning, LLC vs. MDC Properties et al., the Appeals Court recently considered the validity of a liquidated damages provision in a commercial lease agreement. Among other things, the lease agreement obligated the landlord to repair and maintain the property’s HVAC system. The lease contained a provision expressly providing that, in the event the landlord failed to comply with its contractual obligations, “Landlord shall pay Tenant the sum of its actual damages plus $500 per each day until completion of all items.”
When the HVAC system did not work properly, the tenant sued the landlord for breach of contract, seeking in part to enforce the liquidated damages provision. The trial judge held that the liquidated damages provision constituted an unenforceable penalty, in that it assessed an amount in addition to the tenant’s actual damages. Instead of calculating damages as set forth under the lease agreement, the judge assessed damages based on the actual damages suffered by the tenant. Both sides appealed.
The Appeals Court observed that, by the wording of the provision itself, the liquidated damages simply added a penalty to the actual damages, making it improper. The Court concluded that the provision was unenforceable and affirmed the Trial Court’s decision.
This decision states the obvious: since liquidated damages cannot be disproportionate to the actual damages, the calculation of liquidated damages should not be ascertained by adding another amount on top of the “actual damages.”