Black’s Law Dictionary defines liquidated damages as “[a]n amount contractually stipulated as a reasonable estimation of actual damages to be recovered by one party if the other party breaches.” Black’s Law Dictionary, 447 (9th Ed. 2009). Other terms used to describe liquated damages are “stipulated damages” or “estimated damages.” As the definition above suggests, the liquidated damages are agreed upon by both parties during the formation of the contract, and the exact number is included in the contract.
The Supreme Court of Minnesota addressed this issue in Gorco Constr. Co. v. Stein, 256 Minn. 476 (1959), where the parties stipulated that the breaching party would be responsible to pay the nonbreaching party 15% of the contract price. The court reversed the trial court’s decision of calculating damages, holding the liquidated damages must be used. In making its decision, the court stated “[t]he modern trend is to look with candor, if not with favor, upon a contract provision for liquidated damages when entered into deliberately between parties who have equality of opportunity for understanding and insisting upon their rights, since an amicable adjustment in advance of difficult issues saves the time of courts, juries, parties, and witnesses and reduces the delay, uncertainty, and expense of litigation.” Id. at 481. The court expresses its satisfaction with liquidated damages provisions, even commenting it promotes judicial efficiency. The court further held “this court has long regarded provisions for liquidated damages as prima facie valid on the assumption that the parties in naming a liquidated sum intended it to be a fair compensation for an injury caused by a breach of contract and not a penalty for nonperformance.” Id.
In 2008, the Minnesota Court of Appeals narrowed the liquidated damages provision inTenant Constr., Inc. v. Mason, 2008 Minn. App. Unpub. LEXIS 133 (Minn. App. February 5, 2008). The Mason court addressed the situation where a liquidated damages provision in a contract may not be fair compensation. The court held “[i]n deciding whether a [liquidated damages provision] is an unacceptable penalty, the ‘controlling’ factor is whether its amount is reasonable ‘in the light of the contract as a whole, the nature of the damages contemplated, and the surrounding circumstances.’ If ‘actual damages’ cannot be determined under ‘ordinary rules,’ and if a liquidated damage provision is ‘not manifestly disproportionate’ to actual damages, a liquidated-damages provision ‘will be sustained.’ Id. quoting Stein, 256 Minn. at 482-483. The Mason court was concerned with liquidated damages provisions in contracts that did not fairly compensate the nonbreaching party, and therefore the court held the stipulated amount in the liquidated damages provision must be a reasonable amount.
The Minnesota Court of Appeals reached a similar conclusion in 2004 in LeFavor v. Stuebner, 2004 Minn. App. LEXIS 1169 (Minn. App. October 12, 2004), where the court ignored a liquidated damages provision because it was unreasonable. In LeFavor, the appellant was a promisor on a $50,000 note to the appellee. The appellant was to make quarterly payments, which he ended up defaulting. The promissory note (contract) contained a provision that if a party breaches the terms of the promissory note, the breaching party must pay the nonbreaching party $50,000. In reversing the trial court’s decision to enforce the liquidated damages provision, where appellant would pay appellee $50,000 for breaching the terms of the promissory note, the court noted the provision was “greatly disproportionate to any reasonable assessment of compensatory damages.” Id. The court commented that it did favor liquidated damages provisions, stating “[p]roperly used, liquidated-damages provisions allow for prompt settlement of issues that otherwise may present difficulty, uncertainty, delay, and the expense of litigation. To be valid, however, the liquidated sum must be ‘fair compensation for an injury caused by a breach of contract and not a penalty for nonperformance.'” Id. quoting Stein, 256 Minn. at 481. The LeFavor court established a three-step process that must not be passed in order for a liquidated damages provision to be enforced, holding “[t]o determine if an amount is a valid liquidated damages provision, Minnesota courts consider whether (1) the amount represents an impermissible penalty, (2) the harm caused by the breach is susceptible or not susceptible to accurate estimation, and (3) the designated amount is greatly disproportionate to the damages caused by the breach.” Id.