Is That Contract Provision A Penalty or a Liquidated Damages Clause?

READINESS MANAGEMENT SUPPORT LC v. JESCO CONSTRUCTION CORP., Dist. Court, CD Illinois 2011 - Google Scholar

Illinois law enforces liquidated damages clauses, but will not enforce a clause deemed a penalty. The distinction is often difficult to draw as it can be difficult to determine whether a clause provides for a penalty or liquidated damages.

As the court noted: "In interpreting contract provisions that specify damages, Illinois law draws a distinction between liquidated damages, which are enforceable, and penalties, which are not. Checkers Eight Ltd. Partnership v. Hawkins, 241 F.3d 558, 561-562 (7th Cir. 2001), citing Lake River Corp. v. Carborundum Co., 769 F.2d 1284, 1289 (7th Cir.1985). See also, Bauer v. Sawyer, 134 N.E.2d 329, 333-34 (Ill.1956). To be valid under Illinois law, a provision for liquidation of damages must "be a reasonable estimate at the time of contracting of the likely damages from breach, and the need for estimation at that time must be shown by reference to the likely difficulty of measuring the actual damages from a breach of contract after the breach occurs. If damages would be easy to determine then, or if the estimate greatly exceeds a reasonable upper estimate of what the damages are likely to be, it is a penalty." Lake River, 769 F.2d at 1290, citing M.I.G. Investments, Inc. v. Marsala, 414 N.E.2d 1381, 1386 (1981). Accord, Checkers, 241 F.3d at 562, citing American Nat'l Bank & Trust Co. of Chicago v. Regional Transp. Auth., 125 F.3d 420, 440 (7th Cir.1997)."

Here the court deemed the clause a penalty because the cost incurred by the breaching party was far greater than the cost of nonpayment. Thus, the Court granted summary judgment for the defendant County on plaintiff's attempt to enforce the penalty provision.

Comment: the lesson of these cases is to be careful not to ask for too much in a penalty/liquidated damages clause. If you overreach, the provision may be labeled a penalty and become unenforceable.

Edward X. Clinton, Jr.