Liquidated Damages vs. Unenforceable Penalty

ARE LIQUIDATED DAMAGES CLAUSES ENFORCEABLE? – STIPULATED DAMAGES OR UNENFORCEABLE PENALTY?

“The term 'liquidated damages' ordinarily refers to an acceptable measure of damages that parties stipulate in advance will be assessed in the event of a contract breach.” Flores v. Millenium Interests, Ltd., 185 S.W.3d 427, 431 (Tex. 2005); see also Valence Operating Co. v. Dorsett, 164 S.W.3d 656, 664 (Tex. 2005) (“[l]iquidated damages clauses fix in advance the compensation to a party accruing from the failure to perform specified contractual obligations”). Whether a contract term is a liquidated damages clause is a question of law for the court. Valence Operating Co., 164 S.W.3d at 664.

 

If a court determines that a contract term is a liquidated damages clause, the court may then determine whether the clause is enforceable, or whether it is an unenforceable penalty. The policy underlying the prohibition against penalties is to ensure that a party to a contract receives “just compensation,” that is, “neither more nor less than his actual damages.” Phillips, 820 S.W.2d at 788 (quoting Stewart v. Basey, 150 Tex. 666, 245 S.W.2d 484, 485-86 (1952)). In order to enforce a liquidated damages provision and determine the provision is not a penalty, “the court must find: (1) that the harm caused by the breach is incapable or difficult of estimation, and (2) that the amount of liquidated damages called for is a reasonable forecast of just compensation.” Phillips, 820 S.W.2d at 788 (quoting Rio Grande Valley Sugar Growers, Inc. v. Campesi, 592 S.W.2d 340, 342 n.2 (Tex. 1979)).

 

The party asserting that a liquidated damages clause is an unenforceable penalty bears the burden of proof. Urban Television Network Corp. v. Liquidity Solutions, Ltd., 277 S.W.3d 917, 919 (Tex. App.-Dallas 2009, no pet.) (citing Murphy v. Cintas Corp., 923 S.W.2d 663, 665-66 (Tex. App.-Tyler 1996, writ denied)).

CONTENTION MUST BE RAISED AND PLEADED AS AN AFFIRMATIVE DEFENSE
  
Whether a contractual provision is an unenforceable penalty and not a liquidated damage clause is an affirmative defense. See Tex. R. Civ. P. 94; Phillips v. Phillips, 820 S.W.2d 785, 789 (Tex. 1991) (“Although penalty is not among the affirmative defenses enumerated in Rule 94, Tex. R. Civ. P., the listing in that rule is not exclusive. Penalty is, in the language of the rule, a 'matter constituting an avoidance or affirmative defense' [citations omitted].”)
  
SOURCE: Dallas Court of Appeals - 05-09-00586-CV - 5/18/11