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It's The Law: Contract Can Set Amount Of Damages For Breach

Q: I signed a contract to sell my condominium and the buyer backed out. I was lucky to sell it to another buyer, but it sold for $40,000.00 less than the first contract. The buyer under my first contract claims he does not owe me anything because his contract had a clause which said if he defaulted he forfeited his deposit to me as damages. The deposit was only $1,000.00. Is my defaulting buyer right?

A: In certain cases, the parties can agree by contract on what damages will be paid if the contract is breached. This type of clause is known as a liquidated damages provision. These provisions are often found in real estate contracts.

Damages for breach of contract are intended to place the non-breaching party in the same position as if the contract had been performed. That is known as benefit of the bargain. In a breach of contract action, the seller is generally entitled to the difference between what the property would sell for and what it actually sold for.

Primary benefit of a liquidated damages clause is to avoid argument over the amount of damages and hopefully speed resolution of a claim in event of default. From a buyer’s perspective, it limits the potential loss to the amount of deposit. From a seller’s perspective, it will hopefully avoid an expensive fight over the amount of damages and difficulty in proving seller’s actual loss. But, where the agreed upon liquidated damages is small, the seller may be very disappointed.

Where a contract provides that liquidated damages shall be the deposit in event of breach by the buyer, it is important that the seller require an adequate deposit. Otherwise, the contract is, in effect, an option contract for the buyer. If the seller demands a deposit that is extremely large, the effort to forfeit the deposit as liquidated damages may be denied by a court. The liquidated damages must be proportioned to the circumstances and effort by the parties to estimate reasonable loss value.

Liquidated damages provisions are not enforced when they are interpreted as penalties as opposed to an effort to estimate actual damages. The circumstances of each case will affect interpretation as reasonable or penalty by the court.

Courts often look to the intent of parties at time the contract was formed in deciding whether the liquidated damages clause is intended as an estimate of damages or a penalty. Where a contract allows the seller to choose liquidated damages or sue for actual damages, courts have refused to enforce liquidated damages as a penalty because the seller has an option to pursue actual damages.

A liquidated damages clause will not be enforced where it would be relatively easy to determine damages in event of contract breach at the time the contract is created. An example of damages that would be readily ascertainable would be lost profit from sale of a case of light bulbs. At time of contract, the seller knows how much profit and would be entitled to the lost if the buyer defaults.

Although the concept of liquidated damages is relatively simple, the devil is in the details. That makes it important that both buyer and seller review contract documents with an experienced attorney before signature. The exact language of your contract and circumstances of your case may provide you with options that will only be seen by counsel. I recommend you consult with an experienced attorney before proceeding further.

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