Liquidated damages clauses are often included in a variety of commonplace contracts, such as employment agreements, non-solicitation and nondisclosure agreements, and even lease agreements. Such clauses require a party to pay a set amount of damages in the event a party breaches the agreement, and parties to these contracts often blindly assent to such clauses without fully understanding their true effect. But while liquidated damages clauses can be enforceable, that is not always the case. Instead, Minnesota courts carefully scrutinize liquidated damages clauses to ensure they do not impose an unenforceable penalty for breaching the contract. To make this determination, courts focus on: (1) whether the actual damages caused by the breach are ascertainable; and (2) whether the amount of the liquidated damages is reasonable in light of the contract as a whole, the nature of the damages contemplated, and the surrounding circumstances. This scenario recently played out at the Minnesota Court of Appeals in Lagoon Partners, LLC v. Silver Cinemas Acquisition Co., 999 N.W.2d 113 (Minn. App. 2023).
Overview of Lagoon Partners Case
In Lagoon Partners, the parties entered into a lease agreement that contained a somewhat convoluted liquidated damages clause, which stated:
If any statute or rule of law governing the proceedings in which such damages are to be proved shall limit the amount of such claim, Landlord shall be entitled to prove, as and for liquidated damages, by reason of such breach and termination of this Lease, the maximum amount which may be allowed by or under such statute or rule of law. Nothing herein shall limit or prejudice Landlord’s right to prove and obtain as liquidated damages arising out of such breach or termination the maximum amount allowed by any such statute or rule of law which may govern the proceedings in which such damages are to be proved whether or not such amount be greater, equal to, or less than the amount of the excess of the then present worth of the Rent and all other charges reserved herein over the then present worth of the fair market rents and all other charges referred to above.
Due to the COVID-19 pandemic and subsequent civil unrest in Minneapolis during 2020-2021, the tenant, a company that showed specialty and independent films, was unable to operate or pay rent to its landlord. Upon the tenant’s default, the landlord sought to recover possession of the property by commencing an eviction action against the tenant based on its non-payment of rent. After the tenant voluntarily surrendered the property to the landlord, the landlord sought damages under a breach-of-contract theory for just over $1.8 million dollars, reflecting both past and future unpaid rent.
Legal Dispute
On summary judgment, the landlord argued that the liquidated damages clause relieved it of any obligation to prove that it attempted to mitigate damages. The tenant, in turn, argued that the liquidated damages clause was unenforceable and that because questions of fact existed as to the extent to which the landlord mitigated damages, summary judgment was inappropriate. The district court agreed with the landlord that the liquidated damages clause was enforceable and granted summary judgment in the landlord’s favor.
The Minnesota Court of Appeals Reverses
On appeal, the Minnesota Court of Appeals reversed the district court, holding that the liquidated damages clause was unenforceable. Specifically, the court found that because the estimated amount of damages consisted of unpaid rent pursuant to a lease agreement, it would not be difficult to identify and measure the amount of damages the landlord suffered as a result of the tenant’s default. The fact that the effect of the landlord’s mitigation efforts was not fully known did not change the analysis. And the fact that the lease had a rent acceleration clause also solidified the landlord’s damages as it would not be required to assert multiple lawsuits against the tenant to fully recover its damages.
Although the court had already concluded that the liquidated damages clauses was invalid because the landlord’s damages were reasonably ascertainable, it also opined that the clause was invalid because it did not factor in the landlord’s opportunity to mitigate damages. Thus, if the clause was valid, the landlord could both recover damages equal to the defaulting tenant’s future rent payments while simultaneously renting the property for the same amount, resulting in a double recovery that courts generally do not permit.
Implications and Lessons Learned
There are several lessons that businesses and individuals utilizing or relying on liquidated damages clauses should take away from the court’s decision in Lagoon Partners. First, liquidated damages clauses are harder to enforce than some may believe; a party relying on such a clause must establish that their damages are unascertainable (a difficult task) AND that the damages provided for in the clause are reasonable under the circumstances. Thus, such a clause is not a silver bullet for easy recovery. Second, and relatedly, certain contracts are going to be more susceptible to establishing easily ascertainable damages, such as leases or other contracts with finite and discreet contractual terms. Thus, the inclusion of liquidated damages clauses in these types of contracts may prove futile. Lastly, should a contractual dispute proceed to litigation, a party hoping to rely on a liquidated damages clause should be prepared to establish the validity of the clause from the moment the complaint is served, taking steps to avoid ending up in the same scenario as the plaintiff in Lagoon Partners.
