Klug: Recent case illustrates law of liquidated damages in Colorado (column)
The Colorado Supreme Court’s recent decision in Ravenstar v. One Ski Hill Place illustrates the law of “liquidated damages.”
The term liquidated damages means the parties agreed in advance what the damages would be if one party breaches. In many real estate contracts, the parties agree to liquidated damages in the amount of the deposit paid in advance by the buyer. This means the seller does not have to prove “actual damages” if the buyer breaches, which can be difficult to quantify.
In Colorado, a provision to liquidate damages must meet three requirements: (1) the parties intended to liquidate damages; (2) the amount of liquidated damages, when viewed as of the time the contract was made, was a reasonable estimate of the presumed actual damages that the breach would cause; and (3) when viewed again as of the date of the contract, it was difficult to ascertain the amount of actual damages that would result from a breach. If any one of these requirements is not met, the provision is considered an invalid “penalty.” A penalty differs from liquidated damages because it is designed to punish for a breach of contract, whereas liquidated damages are intended as fair compensation for the breach.
As an example, let’s say that A and B enter into a contract. Because A really wants B to perform as agreed, the contract states that, in the event B defaults, B must pay him 1 million dollars. However, A’s actual damages in the event of breach would presumptively be 1,000 dollars. In this case, B’s agreement to pay $1 million is an unenforceable penalty because it is not a reasonable estimate of A’s actual damages in the event of breach (the second requirement above). The law will not enforce this penalty provision.
Returning to Ravenstar, back in 2008, five Colorado companies entered separate contracts with a developer, One Ski Hill Place, LLC (OSHP), to purchase condos at the foot of Peak 8 in Breckenridge. The companies paid earnest money and construction deposits of 15 percent of the purchase price of each condo, but breached the contracts by failing to close due to lack of financing. Each contract contained a provision stating that, if the buyer defaulted, OSHP had the option to retain the paid deposits as liquidated damages or, alternatively, to pursue actual damages and apply the deposits toward any award. OSHP elected to keep the deposits as liquidated damages and the companies sued seeking return of their deposits.
The issue was that the contract gave OSHP the option to choose between liquidated damages and actual damages. The companies argued that this meant the parties did not intend to liquidate damages (so the first requirement for an enforceable liquidated damages provision was not met). The Supreme Court affirmed that the terms of the contract will control. All that is required is an intent to liquidate damages, not that this be the sole and exclusive remedy. The only restriction is that the non-breaching party must elect either liquidated damages or actual damages and may not pursue both. Otherwise, the double-recovery would function as a penalty.
The Supreme Court acknowledged that some courts disallowed provisions of the sort at issue on the basis that the non-breaching party would only elect liquidated damages when they exceeded the actual damages and were therefore a penalty. However, the court did not find these other decisions persuasive because the non-breaching party might elect liquidated damages, even if less than the actual damages, for legitimate reasons such as to avoid costly litigation.
In sum, it is now clear in Colorado that a contract may provide for both liquidated damages and actual damages provided that the non-breaching party must ultimately elect one of those remedies and cannot have both.
Noah Klug is owner of The Klug Law Firm, LLC, in Summit County, Colorado. He may be reached at 970-468-4953 or Noah@TheKlugLawFirm.com.
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