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How to Challenge the Validity of a Liquidated Damages Clause Under New York Law

At the outset, I should point out that the term "liquidated damages" is actually a loaded phrase and has legal significance. Please allow me to explain.

Liquidated Damages v. Unenforceable Penalty

Under New York law, a clause in a contract that provides for a set amount of damages in the event of a breach of the contract regardless of the actual amount of damages sustained - can be deemed either "liquidated damages" (which is enforceable) or a penalty (which is unenforceable).

Ultimately, the decision as to whether the clause in a particular case falls under one category or the other will lie with the Court; it will not go to the jury because the question turns on an issue of law (which is the court's exclusive domain) rather than an issue of fact (which belongs to the trier of fact - usually a jury).

The Burden of Proof at Trial

New York's courts have stated unequivocally that "The burden is on the party seeking to avoid liquidated damages ... to show that the stated liquidated damages are, in fact, a penalty."  See, e.g., JMD Holding Corp. v. Congress Fin. Corp., 4 N.Y.3d 373 (2005); P.J. Carlin Constr. Co. v City of New York, 59 AD2d 847 [1st Dept 1977]; Wechsler v Hunt Health Sys., 330 F Supp 2d 383, 413 [SD NY 2004]).

The Applicable Standard

To that end, New York State's highest court articulated the relevant standard to make this determination as follows:

"A contractual provision fixing damages in the event of breach will be sustained if the amount liquidated bears a reasonable proportion to the probable loss and the amount of actual loss is incapable or difficult of precise estimation. If, however, the amount fixed is plainly or grossly disproportionate to the probable loss, the provision calls for a penalty and will not be enforced."