Parties who have been damaged by breach of contract have always been entitled to just compensation under the law, if they can prove what that is.  Where parties anticipate difficulty in proving specific damages, Texas law allows them to contract for “liquidated damages” which pre-determines damages in the event of a breach.  Such clauses have always been problematic, but last week the Texas Supreme Court reaffirmed its thinking on construing liquidated damages provisions.  The case provides a useful reminder to our clients about remembering to include these provisions, or avoid them, when entering into contracts.

In Atrium Medical Center v. Houston Red C, LLC d/b/a ImageFirst, a hospital entered into a contract with a linen supplier for sixty months of services.  The contract included a liquidated damages clause which stated that if the hospital terminated the agreement, the supplier would be entitled to 40% of its fees times the balance of the agreement.  The contract was terminated, and a jury awarded over $700,000 to the supplier.  The hospital appealed claiming that the provision was just an unreasonably large penalty, not damages, and should not have been enforced.

As part of its analysis of whether the liquidated damages provision in the contract was enforceable, the Supreme Court reaffirmed that the law would enforce liquidated damages clauses where (1) the harm caused by breach is incapable or difficult of estimation, and (2) the damage is a reasonable forecast of just compensation.  The Supreme Court noted further that the problem with many such liquidated damages clauses is the “unbridgeable discrepancy” between the liquidated damages as anticipated and set forth in the contract, and any actual damages in reality.  Crossing the line between a reasonable anticipation and an unreasonable penalty clause will result in having this part of any contract disallowed.

Hirsch and Westheimer recommends that you speak to one of our lawyers to help avoid the pitfalls of an unenforceable liquidated damages provision, or drafting a contract which protects you in the event of a breach.  Our experienced trial lawyers can talk with you about what damages might reasonably be anticipated so that the liquidated damages clause avoids that unbridgeable discrepancy between contract and reality.

If you have questions about liquidated penalty provisions, whether in the context of negotiating a contract or resolving a contractual dispute, please contact 713.220.9140, email jshadwick@hirschwest.com or visit Judge Jeff Shadwick (Ret.) on our site to read more about his practice, as well as about his experience as a former District Court Judge.