Liquidated Damages Clauses: A New Legal Analysis

Kent B. Scott | Babcock, Scott & Babcock | April 5, 2017

There is a new law on the books! The Utah Supreme Court has recently changed Utah law concerning liquidated damages clauses in contracts.  The High Court’s recent ruling simplifies the test used to determine whether or not a court will enforce a liquidated damages provision.

Liquidated Damages Clauses

When a party breaches a contract, the law is designed to compensate the damaged party for the “benefit of his/her bargain. The Court will restore both parties to the position they would have been in, had the contract been fully performed. The liquidated damages clause provides a method and means to calculate damages at the beginning point where the parties are making their contract.

In construction contracts, liquidated damages clauses are usually created to compensate an owner when the contractor does not complete the project on time. This can sometimes be seen as an attempt to penalize the contractor, and the courts generally hold such penalties or “punitive damages clauses” as unenforceable. There is however a general desire to allow both an owner and contractor to contract freely amongst themselves. It is very important that contracting parties read and understand the contract they are signing.

A Change in the Law

In order to address the question as to whether or not a liquidated damages clause should be enforced, the Utah Supreme Court constructed simplified rule that now governs liquidated damage cases. In the recent decision Commercial Real Estate Inv. v. Comcast of Utah II, Inc., the Supreme Court of Utah rejected the previous methods as they were either unnecessary or so complicated that they created contradictory decisions. Now, liquidated damages clauses are to be treated like any other contractual clause and are only unenforceable if there was evidence of mistake, fraud, duress, or unconscionability.

The Future of Challenging Liquidated Damages

The Court’s decision in Commercial Real Estate Inv. v. Comcast of Utah II, Inc., has changed the way the enforceability of liquidated damages clauses can be challenged. There is now an initial presumption that liquidated damages clauses are enforceable, and it is the burden of the party challenging the clause to prove otherwise.

To determine whether a liquidated damages clause is unenforceable, the court now follows a two part test. Summarized, the Court will determine:

  • Is the liquidated damages clause unconscionable? How was the contract created did the one party inappropriately use its superior bargaining power in a way that harmed the weaker party?
  • Did each party have a reasonable opportunity to understand the terms and conditions of the agreement?
  • Was there was a lack of opportunity for meaningful negotiation?
  • Was the agreement was printed on a duplicate or boilerplate form drafted solely by the party in the strongest bargaining position?
  • Were the terms of the agreement explained to the weaker party?
  • Did the aggrieved party had a meaningful choice or instead felt compelled to accept the terms of the agreement?
  • Did the stronger party employ deceptive practices to obscure key contractual provisions?

Conclusion

The Utah Supreme Court has created a clear test and standard to follow in analyzing the enforceability of a liquidated damages clause. The party challenging the enforceability of a liquidated damages clause must prove that the clause is unconscionable, either in its substance or procedure, because there is a presumption that such clauses are enforceable.

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