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Protecting Your Interests With a "Liquidated Damages" Clause

Many business contracts contain a provision for “liquidated damages.” If there is a breach of contract, the injured party may demand a predetermined amount of liquidated damages from the party that caused the breach. As the New York Court of Appeals has explained, “In effect, a liquidated damage provision is an estimate, made by the parties at the time they enter into their agreement, of the extent of the injury that would be sustained as a result of breach of the agreement.”

A liquidated damages provision is designed to compensate a party for its losses. It is not intended to punish the other party for wrongdoing. As a matter of common law, New York courts will not enforce any liquidated damages provision if it requires any payment that is “grossly disproportionate to the amount of actual damages” sustained by the injured party. The Court of Appeals recently discussed the application of these principles in connection with an aborted property lease.

Van Duzer Realty Corp. v. Globe Alumni Student Assistance Association, Inc.

The plaintiff in this case leased a building in Staten Island to the defendant. The initial lease term was one year and later extended for nine additional years. A few months after signing the extension, however, the defendant was cited by New York City officials for “failure to maintain the premises in good order.” Rather than correct the violations, the defendant simply vacated the property and stopped paying rent to the plaintiff.

The plaintiff initially sued the defendant in New York City Civil Court for possession of the property. The Civil Court awarded possession but no monetary damages. The plaintiff then filed a second lawsuit in Richmond Supreme Court against the defendant seeking enforcement of a liquidated damages provision in the lease that required payment of all future rent owed for the remainder of the nine-year term.

The defendant argued the liquidated damages amounted to an “unenforceable penalty.” The Supreme Court disagreed. It awarded summary judgment to the plaintiff and referred the parties to a Special Referee to determine how much the defendant should pay.

In a decision issued on December 18th of this year, the Court of Appeals partially modified the Supreme Court's decision. The appeals court said the defendant was entitled to present evidence the liquidated damages amounted to an unfair penalty. This argument is based on the fact the plaintiff has possession of the property and can release it. This would amount to a “windfall” for the plaintiff, the Court of Appeals, as it would be able to “get the full rent now and hold the property.”

The Court of Appeals did not rule on the merit of the defendant's argument. It only said the Supreme Court must consider whether requiring the accelerated payment of nine years of future rent is “disproportionate” to the plaintiff's actual losses, even though the plaintiff regained possession of the property and has no legal obligation to release.

Cases like this demonstrate the importance of liquidated damage provisions. They can provide important legal protections for parties in the event of a breach. That is why before signing any contract, you should work with a qualified New York business attorney who can advise you on the importance of these types of clauses. Contact our office today if you have any questions.

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