Opinion ID: 526780
Heading Depth: 2
Heading Rank: 3

Heading: The Liquidated Damages Clause

Text: 27 Horn contends that even if her actions did breach the no voluntary participation in litigation covenant in the Yockey-Horn settlement agreement, and even if that promise is not unenforceable as against public policy, Yockey is nevertheless not entitled to collect $50,000 from her because the liquidated damages clause is actually a penalty and thus not enforceable under Illinois law. Horn essentially contends that the $50,000 figure was not at the time of contracting and is not now a reasonable estimate of the damages that might flow from a breach of the no voluntary participation in litigation covenant. 28 Illinois law still recognizes the distinction between a liquidated damages provision and a penalty. See Lake River Corp. v. Carborundum Co., 769 F.2d 1284, 1289 (7th Cir.1985) (collecting Illinois cases). Under Illinois law a two-prong test is used to evaluate liquidated damages clauses: 29 To be valid under Illinois law a 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. 30 Lake River, 769 F.2d at 1289-90 (citation omitted). 31 Where the amount set in a liquidated damages clause is not a reasonable estimate of the damages that might flow from the breach of a contractual promise, Illinois courts have refused to enforce such clauses on the grounds that they are penalties. For example, in Callahan v. Balfour, 179 Ill.App.3d 372, 128 Ill.Dec. 383, 534 N.E.2d 565 (1st Dist.1989), the court refused to enforce a liquidated damages clause appended to a non-compete clause on the grounds that it was a penalty. The liquidated damages clause at issue in Callahan permitted the nonbreaching party to withhold any commission payments owed to the breaching party as of the time of breach. Such a clause was deemed to be a clear penalty provision because the variation in the amount of commission and equity payments which could enure to Balfour as damages rendered the liquidated damages provision ineffective as a reasonable forecast of the actual damages Balfour would suffer from Callahan's breach of the covenant not to compete. Callahan, 179 Ill.App.3d at 378, 128 Ill.Dec. at 387, 534 N.E.2d at 569. 32 This court, applying Illinois law, reached a similar result in Lake River. We refused to enforce a liquidated damages clause which had the effect of not merely compensating the nonbreaching party but provided a windfall unrelated to any damages suffered. See Lake River, 769 F.2d at 1290-92. 33 The court in Pav-Saver Corp. v. Vasso Corp., 143 Ill.App.3d 1013, 97 Ill.Dec. 760, 493 N.E.2d 423 (3d Dist.1986), however, reached a conclusion opposite that of Callahan and Lake River. Pav-Saver adopted the test stated in section 356 of the Restatement (Second) of Contracts to determine whether the amount of damages fixed for wrongful termination under a partnership agreement constituted liquidated damages or a penalty. Section 356, as quoted in Pav-Saver provides: 34 (1) Damages for breach by either party may be liquidated in the agreement but only at an amount that is reasonable in the light of the anticipated or actual loss caused by the breach and the difficulties of proof of loss. A term fixing unreasonably large liquidated damages is unenforceable on grounds of public policy as a penalty. 35 143 Ill.App.3d at 1019, 97 Ill.Dec. at 764, 493 N.E.2d at 427. Furthermore, under Illinois law, [t]he burden of proving that a liquidated damages clause is void as a penalty rests with the party resisting its enforcement. Pav-Saver, 143 Ill.App.3d at 1019, 97 Ill.Dec. at 764, 493 N.E.2d at 427. In the end, the Pav-Saver court found that the liquidated damages clause did not constitute a penalty because the amount was not unreasonable; actual damages would have been around $385,000--the liquidated damages clause provided for around $347,000. 36 Neither of the parties cited any Illinois case that was sufficiently analogous to the present case to provide a clear indication of where, along the continuum between liquidated damages and penalties, the YockeyHorn agreement falls. Our own research failed to reveal a determinative precedent. We are therefore forced to fall back on general principles. We note that comment b under Restatement (Second) of Contracts Sec. 356 states: 37 The amount fixed [in a liquidated damages clause] is reasonable to the extent that it approximates the actual loss that has resulted from the particular breach, even though it may not approximate the loss that might have been anticipated under other possible breaches.... Furthermore, the amount fixed is reasonable to the extent that it approximates the loss anticipated at the time of the making of the contract, even though it may not approximate the actual loss.... If, to take an extreme case, it is clear that no loss at all has occurred, a provision fixing a substantial sum as damages is unenforceable. 38 Restatement (Second) of Contracts Sec. 356 comment b (emphasis added). Essentially, the Restatement creates a rule that favors the enforcement of liquidated damages clauses, if the amount estimated is reasonable either at the time of contracting or at the time of injury. If the nonbreaching party has suffered no damages whatsoever from the breach, the Restatement suggests that the clause will be unenforceable, no matter how reasonable the estimate of damages was at the time of contracting. The example given in the Restatement is a construction contract that contains a $1,000/day liquidated damages clause triggered by delay in completion of the contract. The contractor finishes 10 days late, which entitles the other party to $10,000 under the contract. There is proof, however, that even if the contractor had finished on time the property owner could not have opened his new facility for lack of a license. In such a case the clause would be unenforceable. 39 This example raises questions about the instant case, considering how disproportionate the amount awarded is to the actual damage that Yockey has suffered. Horn quite clearly breached the agreement by voluntarily sitting for the evidence deposition in the Schrock case. But even if she had not breached the agreement the result would have been the same. At oral argument Yockey conceded that he did not believe Horn had any valid defenses to the subpoena power of the Illinois courts. Thus, even if Horn had complied with the letter of the agreement, refusing to testify without a subpoena, she could have easily been subpoenaed and would have given the same testimony. Further, Yockey admits that the judge who entered judgment against him in the Schrock litigation expressly did not rely on Horn's testimony (in the form of her evidence deposition) in finding Yockey liable to Schrock. Horn's testimony went only to Schrock's common law fraud charge against Yockey, on which the judge decided in Yockey's favor. Yockey lost to Schrock on Schrock's statutory claim--Yockey violated the Illinois securities statute. Arguably, therefore, the damages Yockey suffered (his loss in the Schrock litigation) did not flow from Horn's breach of the agreement at all, but solely from Yockey's own wrongdoing. Viewed in this light it appears that Yockey has suffered no injury that could be attributed to Horn's breach of the settlement agreement. 40 This analysis fails to account for other types of damage that Horn's breach might have caused, however, and which fall within the injuries contemplated by the parties at the time of contracting. For example, Yockey's business reputation might have been significantly damaged in the eyes of investors or lenders when Horn, his former business partner, participated in litigation against him that arose out of their former business association. The damages flowing from such an injury would in fact be difficult to evaluate and would be a proper subject for a liquidated damages clause, so long as the parties' estimate is reasonable. 41 As we have noted, the Restatement provides that the reasonableness of the amount set in a liquidated damages clause is to be looked at as of the time of contracting and at the time of actual breach. If at either time the estimate is reasonable, the clause will be enforced. Restatement (Second) of Contracts Sec. 356 comment b. See also J. Calamari & J. Perillo, Contracts Sec. 14-31, at 642 (3d ed. 1987). Illinois law seems to conform to this model. See Likens v. Inland Real Estate Corp., 183 Ill.App.3d 461, 463-64, 131 Ill.Dec. 829, 831-32, 539 N.E.2d 182, 184-85 (1st Dist.1989) (citing Restatement (Second) of Contracts Sec. 356); Pav-Saver, 143 Ill.App.3d at 1018-19, 97 Ill.Dec. at 764, 493 N.E.2d at 427 (same). Although the amount set in this agreement, $50,000, seems large compared to the actual damages experienced, it is not disproportionate to what was anticipated, nor can we say that Yockey experienced no injury as a result of Horn's participation in the Schrock litigation. Because a great deal of damage might have been caused by Horn's breach of the agreement, the $50,000 estimate was reasonable at the time the agreement was made. The liquidated damages clause in the settlement agreement between Yockey and Horn is therefore not a penalty under Illinois law and is thus enforceable.