Liquidated Damage Clauses

A provision in a contract liquidating the damages for the breach of the contract is valid unless the party seeking to invalidate the provision establishes that the provision was unreasonable under the circumstances existing at the time the contract was made. (West's Ann.Cal.Civ.Code § 1671)

Under Cal. Civ. C. § 1671, liquidation clauses are enforceable if at the formation of the contract it was mutually recognized that damages from a breach would be impracticable or extremely difficult to determine with certainty, and (2) the amount or formula stipulated by the parties represented a reasonable endeavor to ascertain what such damages might be. Vregora v. LA Unified School District 152 Cal App 3d. 1178, 1186, 200 Cal. Rptr 103 (1984). The burden of proof is on the party seeking invalidation to show that "the provision was unreasonable under the circumstances existing at the time the contract was made". Cal. Civ. C. 1671(b). A liquidated damage clause will be considered unreasonable and hence unenforceable, if it bears no reasonable relationship to the range of actual damages that the parties could have anticipated would flow from a breach. An amount disproportionate to the anticipated actual damages is termed a "penalty". Ridgley v. Topa Thrift & Loan Assn. 17 Cal 4th 970, 977, 953 P2d 484 (1998). A recent 9th Circuit decision, interpreting California law, has held that, when a lessee continued to perform under the Lease after an initial payment default, the lessor was not entitled to enforce the liquidated damages clause of the contract because it was a penalty. Atel Financial Corporation v. Quaker Coal Company 132 F. Supp 2d. 1233.

The Atel court found that by the time of trial, some payments had been made. Some equipment continued to be leased. There was no "credit default" of the lease as there was no admission, in writing, of an inability to make payments as they come due, which was standard under the lease. By requiring the lessee to pay the present value of all monies during the rest of the lease, plus the anticipated residual value of the equipment, the liquidated damage clause would multiply plaintiff's likely actual damages many times over. The court felt that while such formula might be reasonable in the event of the destruction of the equipment, where no future value in the equipment remained, it was highly disproportionate to the loss of a few loan payments. The anticipated residual value operated without regard to the post-default status of the equipment and whether that status brought Plaintiff any compensation. By continuing to lease the equipment, plaintiff continued to receive income from the equipment, but escaped offset provisions because continuing leasing by the defaulting lessee was not anticipated. The court concluded that the liquidated damage clause gave plaintiff an amount grossly disproportionate to its actual damages. It should be noted that ATEL applied the incomplete arrears payments and all subsequent rentals received against the liquidated damages amount, while continuing to invoice the lessee for rents as they fell due, which the lessee paid in full until all rents were paid.