As we recently explained here in our latest post on the subject, liquidated damages are one way to remedy a breach of contract. Liquidated damages are a specific amount that the parties agree upon in advance as the remedy when one party breaches a contract. That sounds fairly simple. But can the parties also agree in a contract that a non-breaching party can choose between liquidated (the set amount) or actual damages in the event of a breach? Some courts around the country don’t allow this option because it makes the liquidated damages clause seem like a penalty, which is not permitted. The Colorado Supreme Court recently explored whether having liquidated damages as just one rather than the sole remedy makes the clause unenforceable. Coming down in favor of freedom of contract, this case outlines how parties in Colorado have the freedom to bargain as they see fit.
Liquidated Damages in General
Liquidated damages are an exact amount the parties have agreed to in advance to be available if the contract is breached. For example, a non-disclosure agreement might have a liquidated damages clause stating the parties agree that if certain information is disclosed, the breaching party will owe $15,000 in damages. Setting damages up this way can be helpful in situations where it may be difficult to figure out the actual damages from a breach. Liquidated damages clauses are common, but can also ride the fine line between being permissible or invalid. Generally, liquidated damages clauses that operate as a punishment on the breaching party are not enforceable. So, if the clause looks like it is actually intended to be a penalty on the breaching party, it may ultimately be held unenforceable.
In order for a liquidated damages clause to be enforceable, Colorado law requires three elements be met: (1) “the parties intended to liquidate damages”; (2) “the amount of liquidated damages, when viewed as of the time the contract was made, was a reasonable estimate of the presumed actual damages that the breach would cause”; and (3) “when viewed again as of the date of the contract, it was difficult to ascertain the amount of actual damages that would result from a breach.”1
Recently, the Colorado Supreme Court decided a case involving a liquidated damages clause and whether allowing a liquidated damages “option” was permissible.
Ravenstar v. One Ski Hill Place: The Facts2
The case involved a real estate deal gone sideways. Under the deal, the buyers paid earnest money and construction deposits for condo units that a developer was going to build. But ultimately, the deal fell through when the buyers failed to get financing and close the transaction.
Under the parties’ agreement, if the buyers defaulted, the seller had the option of either keeping the earnest money and construction deposit as liquidated damages, or in the alternative, pursuing actual damages. After the buyers defaulted and breached the agreement, the developer chose to keep the deposits as liquidated damages. The buyers sued for return of the deposits, arguing that the damages provision in their agreement was unenforceable because, since it gave the option of choosing liquidated damages or actual damages, there was not a meeting of the minds on liquidating damages. They argued that when set up this way, the clause really operated as a penalty. Their argument goes like this: because there was an option for liquidated damages, but also an option for actual damages, a party would really only choose liquidated damages if they exceeded actual damages, making it more likely that the liquidated damages clause was really a punishment on the breaching party. Thus, the intent of such a clause is punishment, not mutual intent to liquidate damages.
Supreme Court: Parties Can Agree to Either Liquidated or Actual Damages but Must Pick One in the End
The Colorado Supreme Court held that a contract clause that gives the non-breaching party the option between liquidated damages and actual damages “does not invalidate the clause and instead parties are free to contract for a damages provision that allows a non-breaching party to elect between liquidated damages and actual damages.”3 The Court made clear that the first prong of the Colorado test for whether liquidated damages are enforceable does not require that liquidates damages be the only remedy for a breach. All that is required under Colorado law to meet this element is that the parties intended to liquidate damages. “[T]he mere presence of an option to seek either liquidated damages or actual damages does not render the liquidated damages clause invalid as a matter of law.”4
What the parties cannot do, explained the Court, is permit a non-breaching party to obtain both liquidated and actual damages in the end. In other words, these two remedies must be alternatives. Otherwise, the liquidated damages clause would operate as a penalty, which is not permitted under Colorado law.
Drafting Liquidated Damages Clauses after Ravenstar
The Ravenstar case is a straightforward application of freedom of contract, giving parties the benefit of their bargain. Liquidated damages clauses can be useful when damages are uncertain. After this case, it is permissible to have a liquidated damages clause that gives the non-breaching party the option upon a breach to either take the liquidated damages or pursue actual damages. As the Court in this case pointed out, there are several reasons that someone might want liquidated damages, such as the certainty of a fixed amount, or to avoid litigating over actual damages. So, for parties that want to keep their options open, these liquidated damages “option” clauses are now officially available for contracts governed by Colorado law.
1 Klinger v. Adams Cnty. Sch. Dist. No. 50, 130 P.3d 1027, 1034 (Colo. 2006).
2 Ravenstar, LLC v. One Ski Hill Place, LLC, 2017 CO 83.
3 Id. at ¶ 1.
4 Id. at ¶ 15.
Featured Image: Unnamed by Helloquence on Unsplash.com.
- When the Deal Goes Sideways: Understanding Breach-of-Contract Remedies
- Not-so-Secret Secrets are not Sheltered Under Colorado Trade Secret Law
- What Else is in a Contract? Part 3 in a Series on Contracts
- What’s in a Contract? Part 2 in a Series on Contracts
- What is a Contract? Part 1 in a Series on Contracts