Are liquidated damages clauses that allow a non-breaching party to elect an alternative remedy (like lost profits) permissible expressions of private parties’ freedom of contract? Or do such alternatives indicate that the parties never intended to liquidate damages, so as to be an invalid penalty?
Turns out, the answer depends on the state. In Colorado, the courts have decided to leave it to the parties. In a recent decision, Ravenstar, LLC v One Ski Hill Place, LLC (Sept. 2017), the Colorado Supreme Court refused to invalidate a liquidated damages provision that provided an option to elect actual damages, preferring instead to emphasize Colorado’s policy of favoring private parties’ freedom of contract.
In Ravenstar, five Colorado companies and purchasers of condominium units (Ravenstar et al.) sued the developer (One Skill Hill Place (OSHP)), the entity with which they had contracted to purchase the units. At the time of contracting, each purchaser paid OSHP deposits of 15 percent of the purchase price of the unit. The contract provided that, in the event of a default by the purchaser, the seller had the option to either (1) retain the deposit as liquidated damages or, alternatively, (2) recover its actual damages.
The five companies breached their respective agreements with OSHP when they were unable to secure the requisite financing and failed to close. OSHP elected to retain their deposits as liquidated damages. The purchasers filed suit for the return of their deposits, arguing that the liquidated damages clause was invalid and unenforceable.
In Colorado, a liquidated damages provision can only be enforced where three elements are present: (1) the parties intended to liquidate damages; (2) the amount of liquidated damages (as of the time of contracting) was a reasonable estimate of the presumed actual damages that a breach would cause; and (3) the amount of actual damages that would result from a breach was difficult to ascertain as of the time of contracting. If any element is lacking, the provision would be unenforceable and an invalid penalty.
In Ravenstar, the element at issue was the first: Had the parties intended to liquidate damages? The purchasers argued no, and that the fact that the contract allowed the purchaser to pick the alternative option, plaintiff actual damages, was evidence that the parties did not intend to liquidate damages at all.
The Colorado Supreme Court disagreed, observing that “[a]n intent to liquidate damages should not be conflated with an intent to liquidate damages as the sole and exclusive remedy.” The Court observed that, if desired, the parties could—and should—have “bargain[ed] for liquidated damages as a sole and exclusive remedy.” Instead, the parties had expressly agreed to provide the seller with the ability to elect either form of damages in the event of default.
In enforcing the provision as written, the Court emphasized Colorado’s strong policy of freedom of contract and pointing out that a contract involves mutually bargained-for duties and risks. Importantly, however, the Court noted that that such a clause may be enforced only if the option itself is exclusive—in other words, the clause must only allow a non-breaching party to pursue one option, not both. If, on the other hand, both remedies could be pursued, then the provision would be an invalid penalty.
It should be noted that the Colorado Supreme Court’s position aligns with the majority rule, but it is not a universal one. For example, courts in Florida and Illinois have held such alternative clauses unenforceable, while decisions from courts in Washington, Maryland, Tennessee, and Washington, D.C., align with that of the Ravenstar court.
While courts are split on this issue, Ravenstar and decisions from other jurisdictions do convey a single, clear message when it comes to drafting liquidated damages provisions in agreements. Knowing the state of the law of your jurisdiction is nonnegotiable in order to draft an enforceable liquidated damages provision.
Audrey K. Kwak can be reached at email@example.com