Will this liquidated damages clause be enforced, or struck down as a penalty?
It is enforced only if it is a genuine pre-estimate. In Knutton the Supreme Court of North Carolina stated the test, taking the rule inside the inner quotation marks from 22 Am.Jur.2d, Damages § 214: 'whether a stipulated sum will be treated as a penalty or as liquidated damages may ordinarily be determined by applying one or more aspects of the following rule: "[A] stipulated sum is for liquidated damages only (1) where the damages which the parties might reasonably anticipate are difficult to ascertain because of their indefiniteness or uncertainty and (2) where the amount stipulated is either a reasonable estimate of the damages which would probably be caused by a breach or is reasonably proportionate to the damages which have actually been caused by the breach."' If the clause passes, the Court said, again on the authority of that treatise, 'it is the general rule that the amount stipulated in a contract as liquidated damages for a breach thereof, if regarded by the court as liquidated damages and not as a penalty, may be recovered in the event of a breach even though no actual damages are suffered.' Knutton then applied the test and upheld the clause in front of it: the contract's formula 'affords a mathematical method of making certain that which otherwise is very uncertain', the figure it produced was 'a reasonable estimate of the damages which would probably be caused by a breach as it appeared to the parties at the time the contract was made', and 'absent Clause F there is no standard by which a jury could fix with any degree of certainty the amount of damages sustained by plaintiff by reason of the breach', so the sum was liquidated damages and not a penalty, and the Court found no error in the trial below. For a sale of goods the rule is statutory: N.C.G.S. § 25-2-718(a) allows liquidation 'only at an amount which is reasonable in the light of the anticipated or actual harm caused by the breach, the difficulties of proof of loss, and the inconvenience or nonfeasibility of otherwise obtaining an adequate remedy', and provides that 'a term fixing unreasonably large liquidated damages is void as a penalty'.
The trap
Two things drafters get backwards. The test is disjunctive on the second limb but conjunctive overall: Knutton's rule requires BOTH that anticipated damages be difficult to ascertain AND that the sum be a reasonable estimate or reasonably proportionate to the damages actually caused, so a clause attached to a breach whose damages are easy to compute fails on the first limb however modest the number. And § 25-2-718(a) lets the court look at ACTUAL harm as well as anticipated harm, so a number that looked reasonable at signing can still be struck if it is unreasonably large against what in fact happened. North Carolina also caps the seller's side of a broken sale in the buyer's favour: § 25-2-718(b) gives a breaching buyer restitution of any amount by which its payments exceed the sum the seller is entitled to under a term liquidating the seller's damages in accordance with (a) or, absent such a term, twenty per cent of the value of the total performance for which the buyer is obligated or five hundred dollars, whichever is smaller. Read the layaway limb carefully: it is not a flat fifty dollars but, at the seller's election, the aggregate payments the seller received under the contract or fifty dollars, whichever is smaller. The buyer's restitution is then subject to offset under (c) to the extent the seller establishes a right to recover damages under a provision of the article other than (a) and the amount or value of any benefits the buyer received directly or indirectly by reason of the contract.
7 authorities
The words that state the rule
Whether a stipulated sum will be treated as a penalty or as liquidated damages may ordinarily be determined by applying one or more aspects of the following rule: "[A] stipulated sum is for liquidated damages only (1) where the damages which the parties might reasonably anticipate are difficult to ascertain because of their indefiniteness or uncertainty and (2) where the amount stipulated is either a reasonable estimate of the damages which would probably be caused by a breach or is reasonably proportionate to the damages which have actually been caused by the breach." 22 Am.Jur.2d, Damages § 214.
The words that state the rule
Even so, it is the general rule that the amount stipulated in a contract as liquidated damages for a breach thereof, if regarded by the court as liquidated damages and not as a penalty, may be recovered in the event of a breach even though no actual damages are suffered. 22 Am.Jur.2d, Damages § 234
The words that state the rule
Applying the foregoing principles of law to the contract before us, we are of the opinion that the terms of the agreement are within the principles under which such contracts are held to be valid and that the sum to be paid upon breach should be considered as liquidated damages and not as a penalty. The formula for ascertaining the amount of damages, contained in Clause F of the contract, affords a mathematical method of making certain that which otherwise is very uncertain. Furthermore, the result of such calculation is a reasonable estimate of the damages which would probably be caused by a breach as it appeared to the parties at the time the contract was made. In addition, absent Clause F there is no standard by which a jury could fix with any degree of certainty the amount of damages sustained by plaintiff by reason of the breach.
The words that state the rule
Courts do not make contracts. As stated by Higgins, J., in Roberson v. Williams, 240 N.C. 696 , 83 S.E.2d 811 , "Ordinarily, when parties are on equal footing, competent to contract, enter into an agreement on a lawful subject, and do so fairly and honorably, the law does not permit inquiry as to whether the contract was good or bad, whether it was wise or foolish." In the trial below we find No error.
- statuteN.C.G.S. § 25-2-718enactment date not established
The words that state the rule
Damages for breach by either party may be liquidated in the agreement but only at an amount which is reasonable in the light of the anticipated or actual harm caused by the breach, the difficulties of proof of loss, and the inconvenience or nonfeasibility of otherwise obtaining an adequate remedy. A term fixing unreasonably large liquidated damages is void as a penalty.
- statuteN.C.G.S. § 25-2-718enactment date not established
The words that state the rule
(b) Where the seller justifiably withholds delivery of goods because of the buyer's breach, the buyer is entitled to restitution of any amount by which the sum of his payments exceeds (1) the amount to which the seller is entitled by virtue of terms liquidating the seller's damages in accordance with subsection (a) [of this section], (2) in the absence of such terms, twenty per cent (20%) of the value of the total performance for which the buyer is obligated under the contract or five hundred dollars ($500.00), whichever is smaller, or (3) at the election of the seller in the case of a layaway contract, the aggregate payments received by seller from buyer under the contract or fifty dollars ($50.00), whichever is smaller.
- statuteN.C.G.S. § 25-2-718enactment date not established
The words that state the rule
(c) The buyer's right to restitution under subsection (b) [of this section] is subject to offset to the extent that the seller establishes (1) a right to recover damages under the provisions of this article other than subsection (a) [of this section], and (2) the amount or value of any benefits received by the buyer directly or indirectly by reason of the contract.
“Defective” means that reading found something to correct. What you are reading is the rule as it stands after that reading.