For the uninitiated, let's first define what a "liquidated damages" clause is:
What Are "Liquidated Damages"?
In some contracts, Party A may want to have a provision providing that in the event the other party (Party B) breaches the agreement, B concedes that he will be liable to A for a pre-agreed amount of monetary damages. Typically, A will insist on a large dollar figure relative to the amounts being talked about, in order to provide a strong disincentive for B violating his end of the deal.
When a New York Court Will Invalidate a Liquidated Damages Clause
The term "liquidated damages," at least under New York law, means that a court has determined as a matter of law that the specific amount of monetary damages stipulated to in a contract that are to be awarded to one side in the event of a breach of the agreement bear a rational relationship to the anticipated damages, and are reasonable.
On the other hand, if the Court finds that the stipulated money damages for violation of the agreement are completely arbitrary, or are unreasonable when compared to the potential harm that plaintiff could suffer, the Court is obliged to hold the clause unenforceable.
What You Can Still Recover When a Court Refuses to Enforce Your Liquidated Damages Clause
But what happens under New York law if the court invalidates the liquidated damages clause? Is all lost?
The short answer is no.
Fortunately, the courts have expanded on this concept a bit, and given some guidance on this issue, stating:
"If the clause is rejected as being a penalty, the recovery is limited to actual damages proven" (Brecher v Laikin, 430 F Supp 103, 106 [SD NY 1977] [citations omitted]; see also 3 Farnsworth, Contracts 12.18, at 304 [3d ed] [where a liquidated damages provision is an unenforceable penalty, "the rest of the agreement stands, and the injured party is remitted to the conventional damage remedy for breach of that agreement, just as if the provision had not been included"]).