Liquidated damages provisions are generally enforceable if they are intended to compensate the non-breaching party rather than penalize the breaching party.
The Court’s decision in
Young v. Allen Homes
provided more guidance on how to determine whether a particular liquidated damages provision is enforceable in the construction context. This guidance can help owners avoid common mistakes in drafting such provisions before construction begins, and it can help contractors resist unfair liquidated damages claims at the end of a project.
In April 2018, Michael and Debra Young hired Allen Homes to build their new home. The parties’ contract called for a total project price of about $2 million and a non-refundable $80,000 deposit, which the Youngs paid.
After the Youngs fought their HOA for months trying to get approval of their building plans, they gave up, decided to cancel the project, and asked Allen Homes to refund their $80,000 deposit.
When Allen Homes refused, the Youngs filed a lawsuit, arguing that forfeiting the deposit was “unjust enrichment” because it exceeded Allen Homes’ actual and anticipated losses.
Allen Homes counter-sued the Youngs for breach of contract.
The trial court dismissed the Youngs’ unjust enrichment claim, granted Allen Homes’ breach of contract claim, and ordered the Youngs to pay Allen Homes its costs and attorneys’ fees.
The Youngs appealed, renewing their argument that the deposit was an unenforceable penalty, and the Arizona Court of Appeals agreed.
Lessons in Liquidated Damages.
oung v. Allen Homes,
the Court noted that, citing the Arizona Supreme Court’s
, liquidated damages provisions are enforceable if they are intended to
compensate the non-breaching party
penalize the breaching party
decision also stated that a liquidated damages provision is enforceable “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.”
In ruling against Allen Homes, the Court of Appeals found that the deposit, which became fully nonrefundable at the moment it was paid, was an “inflexible forecast of losses” that did not reflect the actual magnitude of Allen Homes’ loss:
“Whether the Youngs breached on the first day of the contract or the hundredth day, they would lose the entire $80,000.00. This fixed amount weighs against concluding that the deposit was a reasonable estimate of anticipated losses at the time the contract was entered into. […] And the contract is silent about what anticipated costs or damages went into arriving at the $80,000.00 figure. On this record, we cannot say that $80,000.00 was a reasonable estimate of anticipated losses at the time the contract was entered.”
The Court ruled that the trial court erred in dismissing the Youngs’ lawsuit and awarding Allen Homes’ attorneys’ fees and costs and sent the case back for trial.
As for the disputed $80,000 deposit, the Court clarified that:
[We] do not conclude that the $80,000.00 provision is necessarily unenforceable, only that on this record $80,000.00 does not reasonably reflect Allen Homes’ actual losses. On a fuller factual record, the superior court may or may not conclude otherwise.
The Court also noted that a liquidated damages provision may be upheld based on the actual loss. Regarding actual damages for the cancellation, Allen Homes claimed it:
paid a supervisor $18,900 for the five months between signing and cancellation;
incurred costs for pre-construction work; and,
lost money by passing up other projects.
But Allen homes provided no dollar amount, much less documentation, to support its claim for pre-construction work and lost opportunities. Similarly, Allen Homes provided no evidence to support its retention of the $80,000 deposit to cover
losses. So, the Court sent the case back to Superior Court for more evidence.
Takeaways for Contractors and Owners
If you want to enforce your liquidated damages amount, do not call it a “penalty” in the contract. A surprising number of parties state up front that they want to penalize the other side for a breach. While a bad label is not absolutely fatal, it does not help.
. The more directly proportional a liquidated damages amount is to the harm caused by the breach, the easier it is to enforce. A flat late fee of 5% on a promissory note – whether one day or one year late – is not proportional and was held unenforceable in
Construction contracts often contain daily liquidated damages amounts. These amounts are certainly proportional to the
of the delay, but they may not be proportional to the harm caused. That is, to be upheld, anticipated damages should “var[y] with the nature and extent of the breach”
(Pima Savings & Loan v. Rampello).
For example, one of our clients was assessed 100% of liquidated damages for a 3,000-foot path, based on an issue with just the last 100 feet. This was obviously disproportional, and the issue would have gone to the jury had we not settled.
. To be enforceable, a liquidated damages provision cannot be just a number pulled out of the air; it needs to have some basis. If you want to position yourself to collect, pencil-out your anticipated losses (such as rents for a building that cannot be opened on time), and then use real numbers. Flat figures with many zeros (like the $80,000 in
Young v. Allen Homes
) are easily challenged. Just as in school, be prepared to show your work.
It may sound backwards, but if you want to enforce a liquidated damages provision, keep close track of your actual damages – for two reasons:
Proving substantial actual damages will support your liquidated damages provision.
If your liquidated damages provision is struck down, you can still prove your actual damages.
Liquidated damages on public projects.
Finally, the recent decisions referenced above give new hope to contractors who face large liquidated damages penalties on public construction projects.
In many cases, public entities do not calculate damage amounts directly; instead, they use a third-party liquidated damages table, such as the Maricopa Association of Governments’ “Standard Specifications for Public Works Construction.” This table simply assigns daily damage amounts based on the amount of the original construction contract – regardless of the type of contract or the actual harm caused by delay. In fact, the amounts are much larger proportionally for smaller contracts.
For example, any job under $25,000 has a $210/day damage provision, while jobs over $10 million face only a $1,780/day charge. At that rate, the liquidated damages would exceed the contract value in four months or less on the smallest jobs, but would not do so for over 15 years on the largest projects.
This math alone will likely help contractors to fight liquidated damages claims on public works projects, and their fight will be aided by additional developments in case law such as
Young v. Allen Homes.