Liquidated damages, remedy substitutes, and remedy limitations

     In the absence of agreement of the parties, remedies for breach of contract are terms that are supplied by default rules.  See Commentary.Default terms.  Like other terms supplied by default rules, these remedies can be altered by agreement of the parties.  See, e.g. U.C.C.. 1-102(3).  In these materials we consider three typical types of terms in agreements that alter the remedies that would otherwise be supplied by default rules: (1) terms that establish liquidated damages, that is, terms that specify an amount of money damages or a formula for deriving an amount of money damages; (2) terms that provide remedies, such as repair, in addition to or in substitution for damage remedies; (3) terms that limit or exclude consequential damages.   

     Both common law and statutes constrain the use of liquidated damage terms.  A term providing for liquidated damages will be enforceable only if damages would be difficult or impossible to prove or calculate at the time of breach and if the liquidated damages constitute a reasonable estimate of either the anticipated or the actual loss from breach.  There is, admittedly, a certain tension between these two requirements:  if damages would be difficult or impossible to prove or calculate, how easily can one reasonably estimate them?  Nonetheless, if a liquidated damages term is not consistent with both of these requirements, the term will be labeled a "penalty" and will be unenforceable.  These requirements, and the use of the word "penalty," are consistent with the principle that remedies for breach of contract may not punish the breaching party for breach but rather should only restore the aggrieved party to the economic position anticipated from performance of the contract.  See Commentary.Compensatory damages and Freeman & Mills, Inc. v. Belcher Oil Co.  
    
     One interesting comparative law analysis attempts to test the theoretical justifications for these limits on contract damages by exploring empirically the use and effect of penalties for non-payment in post-Soviet Russia.  The authors attempt to evaluate whether penalty terms are used by more powerful economic actors to take advantage of less powerful economic actors, whether penalty terms are more often employed by those with greater legal literacy, whether penalty terms are more likely to be used when there is not an established relationship of trust between contracting parties, and whether penalty terms deter efficient breaches.  See Kathryn Henley, Peter Murrell, Randi Ryterman, Punitive Damages for Contractual Breaches in Comparative Perspective:   The Use of Penalties by Russian Enterprises, 2001 Wisc. L. Rev. 639 (Vol. 3).  

     Resnick v. Uccello Immobilien GMBH, Inc., Vanderbilt University v. Dinardo, and R.2d Contracts 356(1) each present slightly different common law expressions of the rule on enforceability of liquidated damages terms.  Resnick considers the enforceability of such a term in an agreement settling a lawsuit alleging violation of the Americans With Disabilities Act. Vanderbilt considers the enforceability of such a term in a contract between a university and its football coach.  In each of those two cases, the parties explicitly identified a clause in the contract as providing for liquidated damages.  In some cases, however, a clause without that label, and sometimes even without language referring to damages at all, will in effect amount to a liquidated damages term; its validity, therefore, must be measured by the standards generally applicable to liquidated damages terms.  See, for example, the clause quoted in an excerpt from the opinion in Lake River Corporation v. Carborundum Co., 769 F.2d 1284 (7th Cir. 1985), which the court held to be an invalid liquidated damages clause.

     UCC 2-718(1) constrains the use of liquidated damages terms in contracts governed by Article 2.  Liquidated damages terms in other contracts may also be governed by statute (e.g. Cal. Civ. Code 1671). 

     Note also that a liquidated damages term might be unenforceable for entirely different reasons applicable to contract terms generally.   For example, in Diosdodo v. Diosdado, 97 C.A.4th 470 (Cal. Ct. App. 2002), a former wife sued her former husband for breaching a term in a written agreement between them, executed after the husband engaged in an extramarital affair, that prohibited either of them from engaging in such an affair in the future and provided liquidated damages of $50,000 in the event of a dissolution of marriage following breach of that term.   After the former husband had another affair, the wife obtained a dissolution and sued to recover the $50,000.  The court held the liquidated damages clause unenforceable because it violated the public policy implicit in California's no-fault divorce laws.  See Commentary.Public policy.

     Instead of providing for liquidated damages, the parties may provide remedies in addition to or in lieu of damages or may limit or exclude consequential damages.  U.C.C. 2-719 governs the use of substitute remedies and the limitation or exclusion of consequential damages in contracts governed by Article 2.  We explore the operation of that section in Problem.Leak in an SUV (Part B), in Milgard Tempering, Inc. v. Selas Corporation of America, and in Problem.Drafting.Excluding consequential damages.  The problem involving the leaking SUV also allows us to explore relevant provisions of a state's "lemon law." 

    Supplementary reading:   Farnsworth 12.18; White & Summers 12-8 to 12-12.