Will South Dakota enforce this liquidated-damages clause, or treat it as a void penalty?
Only if it is a genuine pre-estimate of an otherwise hard-to-fix loss, and the burden of proving that is on the party relying on the clause. SDCL 53-9-4 provides: "Penalties imposed by contract for any nonperformance thereof are void. This section does not void obligations penal in form such as heretofore have been commonly used, but it voids their penal clauses." SDCL 53-9-5 then supplies the narrow exception: "Every contract in which amount of damage or compensation for breach of an obligation is determined in anticipation thereof is void to that extent except the parties may agree therein upon an amount presumed to be the damage for breach in cases where it would be impracticable or extremely difficult to fix actual damage." BankWest, N.A. v. Groseclose confirms how a court resolves which side of that line a clause falls on: "Whether a forfeiture provision is a liquidated damages provision or an unenforceable penalty is a question of law for the court." Impracticability is only the first of THREE elements. Safari, Inc. v. Verdoorn states the test the court actually applies: "Such a provision will be upheld if (1) damages in the event of breach are incapable or very difficult of accurate estimation at the time the contract was made; (2) there was a reasonable attempt by the parties to fix compensation; and (3) the amount stipulated bears a reasonable relation to probable damages and is not disproportionate to any damages reasonably to be anticipated."
The trap
Section 53-9-4's default is void, not valid: a forfeiture or default clause is presumptively an unenforceable penalty, and SDCL 53-9-5's escape hatch is available only where fixing actual damage in advance would have been impracticable or extremely difficult; a round number chosen for convenience, with no such showing, does not qualify. Because whether a clause is liquidated damages or a penalty is a question of LAW rather than a factual label the parties can settle by calling it "liquidated damages" in the contract, the label a drafter chooses does not control the outcome. Clearing element (1) does not save the clause. In Safari, Inc. v. Verdoorn "The trial court held that the damages in the event of breach were extremely difficult to estimate, but the forfeiture provision was a penalty as there was no reasonable endeavor by the parties to fix a fair compensation, and the stipulated damages were not reasonably related to probable damages and were disproportionate to the reasonably anticipated damages. We agree." Element (2) is where boilerplate fails: in Wandler v. Lewis the trial court found that "the default clause in the contract for deed was a void penalty under SDCL 53-9-4," and the supreme court affirmed because "the parties did not discuss fixing compensation or the default provision in general. Without such a discussion or negotiation, the provision constitutes an unenforceable penalty." Wandler is the contract-for-deed case; Safari was the sale of a bar BUSINESS with the real estate leased separately, so do not read Safari as a real-property installment-sale holding. There is also an unresolved tension over who carries the burden: Safari (1989) says "The burden of establishing that such a provision is a penalty rests on the party against whom enforcement is sought," while BankWest (1995) says "The burden of proving that a forfeiture clause is valid as a liquidated damages clause" ... "is upon the party relying on the clause." Both sentences are carried below; this rule follows the later statement, and a litigant should not treat the allocation as settled. Council of Higher Education v. South Dakota Board of Regents also shows §§ 53-9-4 and 53-9-5 have been applied outside ordinary bilateral commercial contracts (there, a public employer's unilaterally imposed liquidated-damages clause in a labor dispute), though that case's ultimate holding on whether the sections reach collective bargaining agreements at all was not read for this rule and is not relied on here.
9 authorities
- statuteSDCL § 53-9-4enactment date not established
The words that state the rule
Penalties imposed by contract for any nonperformance thereof are void. This section does not void obligations penal in form such as heretofore have been commonly used, but it voids their penal clauses.
- statuteSDCL § 53-9-5enactment date not established
The words that state the rule
Every contract in which amount of damage or compensation for breach of an obligation is determined in anticipation thereof is void to that extent except the parties may agree therein upon an amount presumed to be the damage for breach in cases where it would be impracticable or extremely difficult to fix actual damage.
The words that state the rule
Whether a forfeiture provision is a liquidated damages provision or an unenforceable penalty is a question of law for the court.
The words that state the rule
The burden of proving that a forfeiture clause is valid as a liquidated damages clause _ is upon the party relying on the clause.
The words that state the rule
Such a provision will be upheld if (1) damages in the event of breach are incapable or very difficult of accurate estimation at the time the contract was made; (2) there was a reasonable attempt by the parties to fix compensation; and (3) the amount stipulated bears a reasonable relation to probable damages and is not disproportionate to any damages reasonably to be anticipated.
The words that state the rule
The burden of establishing that such a provision is a penalty rests on the party against whom enforcement is sought.
The words that state the rule
Lewis argues the trial court erred when it found that the default clause in the contract for deed was a void penalty under SDCL 53-9-4.
The words that state the rule
These admissions by Lewis’ counsel clearly support the trial court’s finding that the parties did not discuss fixing compensation or the default provision in general. Without such a discussion or negotiation, the provision constitutes an unenforceable penalty.
The words that state the rule
The trial court held that the damages in the event of breach were extremely difficult to estimate, but the forfeiture provision was a penalty as there was no reasonable endeavor by the parties to fix a fair compensation, and the stipulated damages were not reasonably related to probable damages and were disproportionate to the reasonably anticipated damages. We agree.