The Boulder Business Lawyers of LaszloLaw discuss the enforceability of liqudated damages clauses in Colorado.
Contracts often include numerous provision concerning what happens in the event of a party breaching the contact. One such provision that parties might incorporate into the framework of a contract is a liquidated damages provision. Liquidated damages are damages the parties agree to at the time of contracting for which the non-breaching party will be entitled to upon the event of a breach. For instance, a liquidated damages clause may state that any downpayment for services will be retained in the event of a breach.
A liquidated damages provision is added to a contract for many reasons, but primarily its to give the non-breaching party reasonable compensation for the breach, to add certainty to what occurs in the event of a breach, and to possibly reduce the costs inherent to proving damages.
Liquidated Damages in Colorado
However, courts may take a long look at liquidated damages clauses–particularly if they seem unreasonable or unconscionable on their face. In Colorado, liquidated damages clauses are permitted and even “encouraged. In Rohauer v. Little, 736 P.2d 403, 410 (Colo. 1987), the Colorado Supreme Court listed three elements necessary for a valid liquidated damages clause:
- Did the parties intend to liquidate damages?
- When viewed as of the time the contract was made, was the amount of liquidated damages a reasonable estimate of the presumed actual damages that the breach would cause?
- When viewed as of the date of the contract, was it difficult to ascertain the amount of actual damages that would result from a breach?
If a liquidated damages provision does not meet the elements above, then it is deemed a penalty and is unenforceable. Thus, for instance, a liquidated damages clause that contains unreasonably large damages is unenforceable on public policy grounds. This is an important consideration in drafting such a provision because an unenforceable provision in a contract naturally does not serve its intended purpose.
While a party may believe that the liquidated damages clause will protect them in the event of a breach, entitling them to a sum certain amount, if the provision does not meet all the elements above, then it will not be enforced by a court. Of note, the second element above is where parties often go astray in seeking damages: they craft a liquidated damages clause that entails damages that are disproportionate to actual presumed damages as to constitute a penalty. If it’s a penalty, it won’t be enforceable. Thus, any liquidated damages clause should be certain to be reasonable in its amount.
Boulder Business Lawyers
The Boulder business lawyers of LaszloLaw represent and counsel businesses on a number of legal needs, including business formation, risk management, contracts, and litigation. Contact our Boulder business lawyers today at 303-926-0410 or online.