Page 7 - John Hundley 2014

Sharp Thinking

No. 110 Perspectives on Developments in the Law from The Sharp Law Firm, P.C. March 2014

Appellate Court Issues Valuable Primer On

Liquidated Damages Clauses in Contracts

By John T. Hundley, jhundley@lotsharp.com, 618-242-0246

An Appellate Court panel in Chicago has issued a valuable primer on when liquidated damages
clauses will be deemed permissible and impermissible under Illinois law.

In GK Dev., Inc. v. Iowa Malls Fin. Corp., 2013 IL App (1st) 112802, plaintiff purchased four
shopping centers from sellers, one of which locations being subject to a pending long-term lease with
a new anchor tenant. They agreed that at closing $4.3 million would be put in escrow and “forfeited”
by sellers if the contemplated lease and all required governmental permits were not obtained by a
date certain. The permits in fact were not completed until 91 days late. The trial court upheld the
forfeiture provision as a permissible liquidated damages clause.

The Appellate Court reversed. The panel started with the general rule that
“[d]amages for breach by either party may be liquidated in the agreement but only at
an amount that is reasonable in the light of the anticipated or actual loss caused by
the breach and the difficulties of proof of loss. A term fixing unreasonably large
liquidated damages is unenforceable on grounds of public policy as a penalty.” It
noted that the “purpose of damages is to place the nonbreaching party in a position
that he or she would have been in had the contract been performed, not to provide
the nonbreaching party with a windfall recovery,” and that “[i]in doubtful cases, we
are inclined to construe the stipulated sum as a penalty.” Hundley

Construing prior case law, the panel said courts generally will find a liquidated
damages provision valid when three factors are satisfied: “(1) the parties intended to
agree in advance to the settlement of damages that might arise from the breach; (2)
the amount of liquidated damages was reasonable at the time of contracting, bearing
some relation to the damages which might be sustained, and (3) actual damages
would be uncertain in amount and difficult to prove.”

The court said the first prong was failed because all the evidence was that the $4.3 million
provision was based on a possible total loss of the contemplated lease and there was “no evidence
that the parties contemplated damages for a minor delay in obtaining permits. . . . The mere
negotiation and insertion of the liquidated damages clause does not show that the parties intended to
agree in advance that $4.3 million would serve as liquidated damages for a 91-day delay (or any
delay) in obtaining permits.”

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