A clause that addresses damages in a lease agreement between an automobile dealership and the owner of a lot on which the dealer stored cars cannot be enforced because it operates as a penalty, a New York State appeals court in Brooklyn has ruled.
The dispute began in 2008, when the parties agreed that Westbury Jeep Chrysler Dodge (Westbury) would store vehicles on a month-to-month basis on an undeveloped lot owned by the plaintiff. Three years later, they amended the agreement to move the vehicles to a different part of the lot after the owner of the property agreed to lease to a third party the portion previously occupied by Westbury.
The amended agreement, which required Westbury to vacate the original portion of the lot by April 15, 2012, obligated the dealer to pay damages in the amount of $5,000 per day for every day after that deadline that it remained in possession of the original portion. Westbury did not vacate until May 11, allegedly forcing a delay in the start of the owner’s lease with the third party.
The owner accused Westbury of breach of contract and sued to recover $130,000 in damages ($5,000 per day for 26 days). Westbury asked the court to dismiss the damages claim, noting that the delay in starting the lease cost the property owner $57,415. The difference, Westbury charged, constituted a penalty that was disproportionate to the injury suffered by the property owner and therefore unenforceable.
The Appellate Division, Second Department agreed. “Here, [Westbury] demonstrated… that the amended agreement imposed an unenforceable penalty…,” Justice Mark Dillon wrote on behalf of three of his colleagues in a decision on April 12.
The ruling turned on the treatment of so-called liquidated damages (the provision calling on Westbury to pay $5,000 for each day of delay), which represent an estimate by parties to a contract of the extent of injury that a party would suffer in the event of a breach.
Liquidated damages will be upheld when the parties to a contract would otherwise have had difficulty ascertaining damages when they formed the contract and the damages themselves represent a reasonable forecast of the cost of compensating the non-breaching party.
Courts generally will not enforce liquidated damages that impose a penalty or forfeiture. As the Court of Appeals wrote 40 years ago in a ruling that explains the limits of liquidated damages:
A liquidated damage provision has its basis in the principle of just compensation for loss. A clause which provides for an amount plainly disproportionate to real damage is not intended to provide fair compensation but to secure performance by the compulsion of the very disproportion.
In the lawsuit against Westbury, the trial judge concluded that consideration of the claims concerning liquidated damages was premature because questions of fact remained as to who breached the amended agreement.
The Appellate Division disagreed. “The issue of whether the liquidated damages clause is enforceable is readily determinable as a matter of law, without consideration of the unresolved factual issues in this case,” Dillon wrote.