How to Craft Liquidated Damages Clauses That Are Enforceable in NY April 9, 2010

In many long-term contracts, such as in the services industry, it has become rather commonplace for the service provider to insert a liquidated damages clause, which essentially sets forth the specific damages they will be entitled to if the recipient terminates the contract prematurely.

As I’m sure you know, not all liquidated damages clauses are enforceable under New York law; on the other hand, not all of them are unenforceable either.

To the contrary, New York’s courts have long held (as far back as 1977) that  “a liquidated damages provision is enforceable where the fixed amount bears a ‘reasonable proportion to the probable loss and the amount of actual loss is incapable or difficult of precise estimation’ (JMD Holding Corp., supra, 4 N.Y.3d at 380, 795 N.Y.S.2d at 507 (quoting Truck Rent-A-Center v. Puritan Farms 2nd,Inc., 41 N.Y.2d 420, 425, 393 N.Y.S.2d 365, 369 (1977)).”

New York’s courts have shown an increasing tendency to honor these provisions when they are mutually negotiated between two sophisticated businesses that are on equal, or roughly equal footing; conversely, the courts have refused to honor liquidated damage provisions where they are a penalty that is out of scale with foreseeable losses, or where the provisions are being unilaterally imposed by one side on a far weaker second half to a deal, which is also known as “unconscionability.” JMD Holding Corp., supra, 4 N.Y.3d at 378-85, 795 N.Y.S.2d at 506-10; Stenda Realty, LLC v. Kornman, 67 A.D.3d 996, 889 N.Y.S.2d 639 (2d Dep’t 2009).

As a strictly practical matter, the following bears emphasis: a court’s determination as to the validity – or invalidity – of a particular liquidated damages clause will often have to await the end of a case. And the reason for this should be fairly evident: the relationship – or the lack thereof – between the liquidated damages clause and foreseeable losses is a fact-specific one, and requires a full and detailed analysis of the facts of the case. Consequently, as part of your initial contract negotiations, you should consider whether this provision will have enough bite to make it worthwhile to litigate down the line, if this deal ultimately falls apart.

Stated differently (and to quote many of my gurus, including a 15th century mystic): begin with the end in mind.

Jonathan Cooper is a New York Business Litigation and New York Commercial Litigation Lawyer with a focus on New York breach of contract and New York business fraud claims before the Nassau, Queens, Brooklyn, Bronx, Westchester and Suffolk County courts of New York State. For more information, feel free to contact his Long Island office at 516-791-5700.

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