Putting Down a Deposit? Beware of Liquidated Damages Clauses
Florida Contract Law: Liquidated Damages Clauses
In a nutshell, a liquidated damages clause in a contract sets forth a specific sum of money that one party can collect or retain if the other party breaches the contract. The point of such a clause is to settle on an amount of damages ahead of time to avoid litigation if the contract is breached.
In Florida, courts will enforce liquidated damages provisions provided the clause is mutual (i.e., either party can take advantage of the clause), unequivocal (i.e., clear and not ambiguous), and reasonable. Such clauses will not be enforced, however, when they are used to deter a breach or as a penalty against the defaulting party. Simply put, one party to a contract may not hold an excessive penalty over the other party’s head to force compliance with the contract’s terms.
Oftentimes, it is difficult to distinguish between a clause that reasonable and one that is a penalty. Courts usually look to two factors: whether the damages from a breach of the contract can be determined with any certainty; and whether the amount of liquidated damages is grossly disproportionate to the amount of actual damages that might flow from the breach of contract. When in doubt, if the amount of the damages is arbitrary, courts will usually construe the provision as a penalty.
For sake of argument, let’s use a hypothetical. A business earns $500,000 in revenue a year. You get hired by the business, and when you start, you sign a contract agreeing that you will not work for a competing business anywhere in Florida for at least a year after you quit. If you violate that term, the contract states you must pay your former employer $750,000. Most likely, this agreement is going to be held unenforceable because the $750,000 has no relation to the business’s actual damages if you work for a competitor. Instead, the $750,000 in liquidated damages is a penalty intended to induce you to comply with the contract’s terms.
People often unwittingly encounter liquidated damages provisions when one puts down a deposit on a good or a service ahead of time. In essence, the amount put down is the agreed-to damages in the event the purchaser decides not to follow through with the contract for purchase. This can be especially costly in real estate transactions, where buyers may put as much as 10% down at the time of signing the purchase contract. Florida courts generally will enforce a liquidated damages clause that requires the surrender of a deposit. Thus, whenever you put money down ahead of time, make sure you read the contract and understand the specific terms relating to your deposit, or you could be out a boatload of money.
Do you have a question about business contract law or breach of contract?
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