When is a liquidated damages clause valid and enforceable?

  
WHAT IS A LIQUIDATED DAMAGES PROVISION IN A CONTRACT?
 
A valid liquidated damages clause estimates in advance the just compensation a party will accrue if the other party to the contract fails to perform. Valence Operating Co. v. Dorsett, 164 S.W.3d 656, 664 (Tex. 2005). “Whether a contractual provision is an enforceable liquidated damages provision or an unenforceable penalty is a question of law[.]” Phillips v. Phillips, 820 S.W.2d 785, 788 (Tex. 1991).
 
ENFORCEABILITY OF CONTRACTUAL LIQUIDATED DAMAGES PROVISION
 
In determining whether a liquidated damages clause is enforceable, courts examine (1) whether the harm caused by the prospective breach of the contract is incapable or difficult of estimation and (2) whether the amount of liquidated damages called for is a reasonable forecast of just compensation. Id. If either element is lacking, the liquidated damages clause is unenforceable. Arthur’s Garage, Inc. v. Racal-Chubb Sec. Sys., Inc., 997 S.W.2d 803, 810 (Tex. App.—Dallas 1999, no pet.).
  
Evidence regarding the difficulty of estimating damages and whether the amount of liquidated damages is a reasonable forecast of just compensation, must be viewed as of the time the contract was executed. Baker v. Int’l Record Syndicate, Inc., 812 S.W.2d 53, 55 (Tex. App.—Dallas 1991, no writ) (op. on reh’g); see also Oetting v. Flake Unif. & Linen Serv., Inc., 553 S.W.2d 793, 796 (Tex. App.—Fort Worth 1977, no writ). “If the liquidated damages are proven to be disproportionate to the actual damages, the liquidated damages can be declared a penalty and recovery limited to actual damages.” TXU Portfolio Mgmt. Co., L.P. v. FPL Energy, LLC, 328 S.W.3d 580, 589 (Tex. App.—Dallas 2010, pet. filed) (citing Baker, 812 S.W.2d at 55).
  
The burden of proving a penalty defense is on the party challenging the liquidated damages clause. Baker, 812 S.W.2d at 55; see also Urban Television Network Corp. v. Creditor Liquidity Solutions, L.P., 277 S.W.3d 917, 919 (Tex. App.—Dallas 2009, no pet.). Generally, the party asserting this defense must prove the amount of the other party’s actual damages, if any, to show that the liquidated damages set forth in the agreement were not an approximation of actual loss. Baker, 812 S.W.2d at 55; TXU Portfolio, 328 S.W.3d at 589. SOURCE: Beaumont Court of Appeals - 09-10-00361-CV - 5/19/11 (Thus, the liquidated damages provision for the payment of $20,000 was not a reasonable forecast of just compensation for any allowable damages resulting from [ PARTY'S ] breach of the agreement. We hold the liquidated damages clause is unenforceable.)
 
RELATED CASELAW CLIPS:
 
We enforce a liquidated damages clause if (1) the harm caused by the breach is incapable or difficult of estimation, and (2) the amount of liquidated damages is a reasonable forecast of just compensation. See Phillips v. Phillips, 820 S.W.2d 785, 788 (Tex. 1991). An assertion that a liquidated damages provision constitutes an unenforceable penalty is an affirmative defense, and the party asserting penalty bears the burden of proof. See Urban Television Network Corp. v. Liquidity Solutions, 277 S.W.3d 917, 919 (Tex. App.-Dallas 2009, no pet.); Fluid Concepts, Inc. v. DA Apts., LP, 159 S.W.3d 226, 231 (Tex. App.-Dallas 2005, no pet.). Generally, that party must prove the amount of actual damages, if any, to demonstrate that "the actual loss was not an approximation of the stipulated sum." Baker v. Int'l Record Syndicate, Inc., 812 S.W.2d 53, 55 (Tex. App.-Dallas 1991, no writ). If the amount stipulated in the liquidated damages clause is "shown to be disproportionate to actual damages," we should declare that the clause is a penalty and limit recovery to actual damages. Johnson Eng'rs, Inc. v. Tri-Water Supply Corp., 582 S.W.2d 555, 557 (Tex. Civ. App.-Texarkana 1979, no writ); see also TEX. BUS. & COM. CODE ANN. § 2.718(a) (Vernon 2009) ("A term fixing unreasonably large liquidated damages is void as a penalty.").

Whether a liquidated damages clause is an unenforceable penalty is a question of law for the court, but sometimes factual issues must be resolved before the court can decide the legal question. See Phillips, 820 S.W. 2d at 788. For example, in Phillips, the Texas Supreme Court observed that "to show that a liquidated damages provision is unreasonable because the actual damages incurred were much less than the amount contracted for, a defendant may be required to prove what the actual damages were." Id. SOURCE: Houston Court of Appeals - 01-09-00155-CV - 10/21/10 Whether a liquidated damages provision is an enforceable contractual provision or an unenforceable penalty is a question of law. Phillips v. Phillips, 820 S.W.2d 785, 788 (Tex. 1991). To find a liquidated damages provision enforceable, a court must find that (1) the harm caused by the breach is incapable or difficult of estimation, and (2) 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 difficulty of estimation of harm must have existed at the time the contract was executed. See Murphy v. Cintas Corp., 923 S.W.2d 663, 666 (Tex. App.-Tyler 1996, writ denied).

SOURCE: Austin Court of Appeals - 03-09-00063-CV - 6/11/10

A valid liquidated damage provision estimates in advance the just compensation to a party accruing from the failure to perform certain contractual obligations. See Valence Operating Co. v. Dorsett, 164 S.W.3d 656, 664 (Tex.2005); Stewart v. Basey, 150 Tex. 666, 245 S.W.2d 484, 486 (1952). In general, the issue of whether a contractual provision is an enforceable liquidated damage clause or an unenforceable penalty is a question of law for the court. See Phillips v. Phillips, 820 S.W.2d 785, 788 (Tex.1991). In making this determination, we examine whether the harm caused by the prospective breach of the contract is incapable or difficult of estimation and whether the amount of liquidated damages is a reasonable forecast of just compensation. Id.; Baker v. Int'l Record Syndicate, Inc., 812 S.W.2d 53, 55 (Tex.App.-Dallas 1991, no writ). The evidence concerning the difficulty of estimation and the reasonableness of the damages forecast must be viewed as of the time the contract was executed. Baker, 812 S.W.2d at 55. The party asserting that the provision is an unenforceable penalty has the burden of proof. See Fluid Concepts, Inc. v. DA Apartments Ltd., P'ship, 159 S.W.3d 226, 230-31 (Tex.App.-Dallas 2005, no pet.). Where, as here, the parties have filed cross-motions for summary judgment, we may reverse and render the judgment that the trial court should have rendered. See CU Lloyd's of Tex. v. Feldman, 977 S.W.2d 568, 568 (Tex. 1998) (per curiam).
 
SOURCE: Dallas Court of Appeals - 05-08-01584-CV 7/27/10