Liquidated Damages Provide Measure of Certainty Under New Jersey Contract Law

New Jersey Business Law and Liquidated Damages

Business parties draft contracts to give them a measure of certainty in their future relationship.  However, it is not a secret that contracts are frequently breached, so parties often want a degree of certainty about what will happen in the event of a future breach.  This gives rise to greater likelihood that the contract will be performed, and hopefully limits litigation costs if there is a breach.  However, New Jersey business law, and indeed contract law generally, prohibits penalties in contracts.  Thus, damages for breach of contract must reflect actual damages to put the innocent party in as good a place as it would have been had the breach not happened, rather than a greater amount to penalize a breaching party.

But when drafting a contract for a business relationship which will be performed in the future, it is often impossible to know what the amount of damages will be.  Too many things are unknown, such as whether the relationship will be profitable and if so how profitable; and how much time will remain on the contract when a breach occurred, and thus how long the damages will accrue.   For this reason New Jersey contract law allows for liquidated damages.  Liquidated damages are an estimate of actual damages included in a contract to give more certainty about what will happen in the event of a breach.  But liquidated damages must be a good faith estimate of actual damages in order to be valid and enforced.

 

The Nixon Medical Apparel & Linen Case

A good example of the application of liquidated damages is contained in the recent Appellate Division case of Nixon Medical Apparel & Linen Service Specialist vs Surgery Center LLC.  In this Case, Nixon and Surgery Center entered into a written contract with a three year term under which Nixon would provide services and linens for the Center.  As the Court explained,

The contract covered a thirty-six-month period and would be automatic[ly] renewed unless defendant notified plaintiff at least ninety days prior to the contract’s expiration. The contract provided that if defendant had “complaints about the quality of service that [were] not … resolved during the normal course of business,” it was required to submit written notice “by registered mail” to plaintiff’s president, Jason Bernstein, and allow plaintiff an opportunity to make a “good faith effort” to resolve the issue “within thirty days of receipt” of the notice. If plaintiff did not resolve the issue, defendant could terminate the contract so long as certain conditions were met, including the payment of any outstanding balance.

The contract also contained a liquidated damages clause which provided,

In the event of cancellation of this agreement, the parties agree that the damages that will be sustained by [plaintiff] will be substantial and difficult to ascertain. Therefore, if this [contract] is cancelled by [defendant] prior to the termination date for any reason other than for failure of [plaintiff] to perform under its guarantee or; if this agreement is terminated by [plaintiff] for cause, [defendant] agrees to pay to [plaintiff], as liquidated damages and not as a penalty, either [fifty percent] of the average weekly invoice amount for the preceding ninety day period times the unexpired term or, purchase all items, whether in service with [defendant] or held in stock by [plaintiff], at [its] standard replacement values then in effect. Prior to termination, [defendant] will also be responsible for any unpaid charges on [its] account.

During the first year of the contract, Surgical Center raised concerns, all of which were the result of a Nixon employee being on three month leave, and all of which were resolved.  Thereafter, Nixon suspended service for a period of time because of Surgical Center’s failure to make payment, but this was resolved as well, and service continued.

Then, on November 30, 2017, when Surgical Center owed $18,509.75, it terminated the contract without notice.  It  claimed that this was because of product shortages, soiled linens, and lack of communication.  However, it had never given notices of any of these issues to Nixon or given it an opportunity to cure these supposed deficiencies, and prior to terminating the contract it had entered into a new agreement with another supplier (Unitex) for the exact same services at a lower price.

Nixon sued Surgical Center for breach of contract in the Law Division of the Superior Court of New Jersey, in Bergen County, seeking the unpaid $18,509.75, plus liquidated damages for a total of $157,066.21 (the Law Division is the trial division of the Superior Court for civil cases seeking mainly monetary damages).  Judge Estela M. De La Cruz granted summary judgment in Nixon’s favor.

Surgical Center appealed to the Appellate Division of the Superior Court of New Jersey.

 

The Appellate Division’s Opinion

The Appellate Division rejected Surgical Center’s Arguments.  It adopted Judge De La Cruz’s factual findings verbatim.  It summed up its factual findings thus.

In sum, the record demonstrates that defendant terminated the contract less than a year after it was entered without providing plaintiff with notice of performance issues and the opportunity to cure as required by the contract. There was no genuine issue of material fact presented, and damages were awarded consistent with the contract terms between two sophisticated business entities.

It also adopted Judge De La Cruz’s summary, which is a useful and concise summary of the law on liquidated damages and application to the facts in an actual, real world scenario.

… A liquidated damages clause is enforceable so long as [ ](a) the amount so fixed [“]is a reasonable forecast of just compensation for the harm that is caused by the breach,” and (b) the harm that is caused by the breach is one that [“]is incapable or very difficult of accurate estimate.” Given that [defendant’s] new contract [with Unitex] also provides a virtual[ly] mirrored liquidation clause causes great conflict for it to now argue unreasonableness in the contract [with plaintiff].

 

The Takeaway

Liquidated damages are a valuable tool provided by New Jersey business law to provide contracting parties with a measure of certainty that they will get the benefit of their bargain should the other side breach, and to know what that benefit will be or give them a means to calculate it.  However, the provision cannot be a penalty; if the liquidated damages provision is not a good faith attempt to reasonably estimate actual damages it will be considered a penalty and struck down by a reviewing court.

 

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