liquidated damages or unenforceable penalty clause?

Liquidated damages work injury claim form - The Procurement School

Procurement professionals are aware that any liquidated damages clauses in contracts must represent a reasonable pre-estimate of the losses that will be sustained in the event of the enumerated contract breach. While not an exact science, such clauses will not be enforced by the courts if the damages payable are out of proportion to the losses suffered by the aggrieved party.

So does a $500,000 damages clause constitute an unenforceable penalty, or a reasonable pre-estimate of liquidated damages? How do the courts actually approach this analysis when losses cannot be precisely quantified, and how does the principle of freedom of contract play into it? These were some of the important questions addressed by the B.C. Supreme Court in the decision of Badesha v. Snowland Sporting Goods Ltd., 2015 BCSC 1229.

The case involved two inter-related contracts to facilitate a land swap deal based in Chilliwack, B.C. The contract’s damages clause included a term stating that if either the buyer or the seller failed to complete the terms and conditions of the contract, the defaulting party would have to pay $500,000 to the other party within 60 days of the default. Under these provisions, the plaintiff sought a total of $1 million in liquidated damages from the defaulting purchaser.

In reviewing the case law related to liquidated damages, the B.C. Supreme Court (BCSC) referred to the Supreme Court of Canada’s pronouncements in H.F Clarke Ltd. v. Thermidaire Corp., [1976] 1 S.C.R. 319 at 338 that the clause is a penalty clause “if the sum is extravagant and unconscionable in comparison to the greatest loss that could conceivably be proved to have followed from the breach.” Relying on Tkachuk Farms Ltd. v. Le Blanc Auction Service Ltd., 2006 SKQB 536 (CanLII), the BCSC concluded that where the exact damages that may result from a breach are not ascertainable at the time the agreement is made, the clause may be upheld where it is not disproportionate to the probable loss. Thus penalty clauses, or those which are disproportionate to the probable loss, are generally not enforceable.

So how did the court apply these principles to the land swap deal that fell apart prior to completion? There were two properties involved in the land swap: the hotel property and the Young Street property. The evidence showed that for the hotel contract, the deposit paid was $50,000 on a $3 million purchase price, and for the Young Street contract the total deposit was $100,000 on a $4.8 million purchase price. The Court accepted evidence that deposits on the sale of commercial buildings normally range from 10 – 15 percent, and that in this case the deposit should be calculated with regard to the purchase price of each property rather than to the difference in price between the two properties.

Based on this evidence, the Court concluded the average deposits would be:

  1. Hotel purchase price $3 million x 15 percent = $450,000 deposit
  2. Young Street purchase price $4.8 million x 15 percent = $720,000 deposit

The Court ruled that the damages clause was thus not penal in nature and that the courts should not interfere where the clause is both clear and unequivocal, and where the parties have agreed to it. The principle of freedom of contract means that the courts will respect the terms of an agreement voluntarily entered into by legally capable parties, unless there are extreme circumstances, such as a gross imbalance of bargaining power, duress or fraud. In this case, there was no evidence of such extreme circumstances.

The Court found no need to specifically quantify the losses of the plaintiff in light of ancillary evidence showing the clause to be reasonable, and further stated that if the clause were found to be penal in nature, it would then be up to the plaintiff to establish entitlement to relief on the balance of probabilities. The Court accordingly awarded judgment to the plaintiff in the amount of $1 million, dismissed the counterclaim and left the parties to agree on costs or to make further submissions regarding costs if necessary.

The lessons from this case are clear: ensure that the amount of any ‘penalty clause’ in your contracts represents a reasonable pre-estimate of what your organization will lose if the other party defaults. You need not be exact, but the amount should be reasonably well thought-out, defensible and – where possible – detailed in the contract.

Looking for More on Liquidated Damages?

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Readers are cautioned not to rely upon this article as legal advice nor as an exhaustive discussion of the topic or case.  For any particular legal problem, seek advice directly from your lawyer or in-house counsel.  All dates, contact information and website addresses were current at the time of original publication.

0 thoughts on “liquidated damages or unenforceable penalty clause?

  • The question thus becomes for an employee. Should a company have the right to put in contract a liquidate damage claim of 40% on an employee, should they be fired from said company. Should not the clause work both ways? They fired the person thus owe them 40% instead of them firing the person and then trying to collect 40% of their salary?
    Sinclair Broadcasting is doing this in the USA, so was wondering what it would look like up here.

    • Maureen Sullivan, President of NECIsays:

      Not quite sure I understand your question, Robert, but I will take a stab at answering it anyways. This article deals specifically with ‘liquidated damages’ clauses in the Canadian legal context, which requires such clauses to be a ‘reasonable pre-estimate of losses’. Eg. ‘for every day the project is delayed, we deduct $500 from your invoice’ – assuming the owner can justify $500 a day as being reasonable (for example, extra equipment charges and foreman oversight per day), the courts will not interfere. The law on this may be different in the US.

      It sounds, however, that you are talking about other types of contracts such as employment contracts. The general rule in Canada is ‘freedom of contract’. In other words, the courts will not interfere with a ‘bad bargain’ as long as the parties are both of legal capacity, sound mind etc. If the employee signed a contract with that provision (which seems rather bizarre to me without more context) they could have insisted on a reciprocal provision at the time of negotiations. Generally speaking, once a contract is signed, it is too late to argue that it is unfair.

      Hope this helps!

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