Will a Texas court enforce this liquidated-damages formula, or strike it as an unenforceable penalty?
A court will enforce a liquidated-damages provision only on two findings: that the harm caused by the breach is incapable or difficult of estimation, and that the amount is a reasonable forecast of just compensation. A provision that fails either is an unenforceable penalty. Both prongs are evaluated from the perspective of the parties at the time of contracting. A provision that passes as written may still be unreasonable 'because the actual damages incurred were much less than the amount contracted for', and on that assertion the BURDEN is on the party resisting the clause ('The burden of proving unreasonableness falls to FPL'), which may be required to prove the amount of actual damages before a court will classify the provision as a penalty; the enforceability of the provision is ultimately a question of law for the court. Penalty is a defence in the nature of an avoidance or affirmative defence, which ordinarily must be pleaded, but it 'is not waived by the failure to plead it if it is apparent on the face of the petition and established as a matter of law' (Phillips v. Phillips). Both authorities ran to a result, and the results point the same way: in Phillips the multiplier clause met NEITHER prong and the Court affirmed the court of appeals; in FPL Energy the Court held the liquidated-damages provisions applied only to renewable energy credits and were unenforceable as a penalty, affirming on one issue, reversing in part and remanding for damages. A provision operating with no rational relationship to actual damages, so that it is unreasonable in light of them, is unenforceable.
The trap
A round-number or formulaic damages clause that bears no relationship to the actual anticipated harm reads as a penalty regardless of what the contract calls it: Phillips itself struck a clause fixing ten times actual damages, precisely because a multiplier concedes that actual damages can be calculated. The pleading point is the one drafters get backwards in both directions. It is not enough to say that penalty must be pleaded or it is waived: where the plaintiff's own petition shows the clause is a penalty as a matter of law, a general denial preserves the defence, because pleading an unenforceable provision anticipates the defence. Nor is the exception general ('Whenever the defense is not clearly established on the face of the pleadings ... it must be pleaded'), and where unreasonableness turns on what the actual damages were, the party resisting the clause carries the burden of proving them. The other direction matters too: FPL Energy holds that Phillips 'did not create a broad power to retroactively invalidate liquidated damages provisions that appear reasonable as written': a clause that was a reasonable forecast when made is not undone merely because the actual loss came in lower. Do not read FPL Energy's limiting sentence as a win for the clause. The same opinion STRUCK the liquidated-damages provisions: it held a deficiency rate keyed to a regulator's later determination, with actual credit values ranging from $4 to $14 and the court of appeals' $29 million award implying an effective rate of $132 per credit, operated 'with no rational relationship to actual damages', and that 'the liquidated damages provisions apply only to RECs and are unenforceable as a penalty'. The sentence that joins the limit to the result is the Court's own: Phillips created no broad power to retroactively invalidate provisions that appear reasonable as written, 'But when there is an unbridgeable discrepancy between liquidated damages provisions as written and the unfortunate reality in application, we cannot enforce such provisions.' So the one sentence a drafter would lean on for the idea that a clause reasonable as written survives comes from a case in which the clause did not survive. And read Phillips's reasoning, not just its pleading holding: the multiplier clause failed BOTH prongs, the first because the harm was 'not incapable or difficult of estimation' and the clause assumes actual damages must be determined before the multiplier can be applied, the second because instead of forecasting damages it calls for them to be determined and then multiplied.
9 authorities
The words that state the rule
Enforcement of an illegal agreement violates public policy. Id. For the same reasons, we hold that the defense of penalty is not waived by the failure to plead it if it is apparent on the face of the petition and established as a matter of law. Enforcement of a penalty, like enforcement of an illegal contract, violates *790 public policy. RESTATMENT (SECOND) OF CONTRACT § 356; see State v. Alpha Oil & Gas, Inc., 747 S.W.2d 378 (Tex.1988). It should not be done, even if the parties do not object. In this case Martha pleaded that she was "entitled to damages ... in the amount of ten (10) times all losses suffered". Inasmuch as Martha's own pleading establishes that the contractual provision she relies upon is an unenforceable penalty under our decisions in Stewart and Campesi as a matter of law, Harry was not required to plead penalty as an affirmative defense.
- case426 S.W.3d 59FPL Energy, LLC v. TXU Portfolio Management Co.Tex.decided 2014read it at the source ↗
The words that state the rule
The basic principle underlying contract damages is compensation for losses sustained and no more; thus, we will not enforce punitive contractual damages provisions. See Stewart v. Basey, 150 Tex. 666 , 245 S.W.2d 484, 486 (1952). In Phillips v. Phillips, we acknowledged this principle and restated the two indispensable findings a court must make to enforce contractual damages provisions: (1) “the harm caused by the breach is incapable or difficult of estimation,” and (2) “the amount of liquidated damages called for is a reasonable forecast of just compensation.” 820 S.W.2d 785, 788 (Tex.1991) (citing Rio Grande Valley Sugar Growers, Inc. v. Campesi, 592 S.W.2d 340 , 342 n. 2 (Tex.1979)). We evaluate both prongs of *70 this test from the perspective of the parties at the time of contracting. 2 In Phillips we recognized that, under this test, a liquidated damages provision may be unreasonable “because the actual damages incurred were much less than the amount contracted for.” 820 S.W.2d at 788 . A defendant making this assertion may be required to prove the amount of actual damages before a court can classify such a provision as an unenforceable penalty. Id. While the question may require a court to resolve certain factual issues first, ultimately the enforceability of a liquidated damages provision presents a question of law for the court to decide.
The words that state the rule
If the general partner breaches his trust hereunder, he shall pay to the limited partner as liquidated damages ten times the amount she loses as a result of such breaches of trust. Errors of judgment shall not be considered breaches of trusts.
The words that state the rule
we do not hold that the affirmative defense of penalty need never be pleaded. Whenever the defense is not clearly established on the face of the pleadings, as it is here, it must be pleaded. We do not "resurrect[ ] trial by ambush", post, at 790, or "retreat from ... encouraging full disclosure during discovery", post, at 792. We apply a narrow but necessary exception, long and well established, to the general requirement that affirmative defenses be pleaded
- case426 S.W.3d 59FPL Energy, LLC v. TXU Portfolio Management Co.Tex.decided 2014read it at the source ↗
The words that state the rule
we recognized that a liquidated damages provision may be unreasonable in light of actual damages. 820 S.W.2d at 788 . The burden of proving unreasonableness falls to FPL. See id. The court of appeals held that FPL failed to meet this burden, yet the court’s evaluation was based on evidence of damages for electricity and RECs. 328 S.W.3d at 589-90 . Our holding on the scope of the liquidated damages clauses limits our consideration to damages for REC deficiencies. The evidence reviewed in this opinion demonstrates that FPL has met its burden. Phillips did not create a broad power to retroactively invalidate liquidated damages provisions that appear reasonable as written. See 820 S.W.2d at 788 . Nor do we create such a power here. But when there is an unbridgeable discrepancy between liquidated damages provisions as written and the unfortunate reality in application, we cannot enforce such provisions.
The words that state the rule
The enforceability of the contractual provision in this case involves no fact issues. A contractual provision like the one here by which one party agrees to pay the other some multiple of actual damages for breach of the agreement does not meet either part of the legal test for an enforceable liquidated damages provision. It cannot meet the first prong of the test because the harm caused by the breach of the contract is not incapable or difficult of estimation. The provision assumes actual damages can and will be determined, indeed must be determined, before the prescribed multiplier can be applied. The provision cannot meet the second prong of the test because, instead of attempting to forecast actual damages, it calls for them to be determined and then multiplied. Cf. Robert G. Beneke & Co. v. Cole, 550 S.W.2d 321 (Tex.Civ.App.Dallas 1977, no writ) (contract provision which fixes liquidated damages without excluding additional liability for actual damages is not a reasonable forecast of just compensation and therefore a penalty). A contractual provision like the one in this case is thus, on its face, an unenforceable penalty.
The words that state the rule
we conclude that Martha is not entitled to recover ten times her actual damages. Finding no error in the judgment of the court of appeals, we affirm it.
- case426 S.W.3d 59FPL Energy, LLC v. TXU Portfolio Management Co.Tex.decided 2014read it at the source ↗
The words that state the rule
We affirm the court of appeals’ holding that TXUPM owed no contractual duty to provide transmission capacity. However, we hold the liquidated damages provisions apply only to RECs and are unenforceable as a penalty. Accordingly, we reverse the court of appeals’ judgment in part and remand the case to the court of appeals to determine damages.
- case426 S.W.3d 59FPL Energy, LLC v. TXU Portfolio Management Co.Tex.decided 2014read it at the source ↗
The words that state the rule
When the liquidated damages provisions operate with no rational relationship to actual damages, thus rendering the provisions unreasonable in light of actual damages, they are unenforceable.
“Defective” means that reading found something to correct. What you are reading is the rule as it stands after that reading.