Colorado Supreme Court upholds optional liquidated damages provisions

This week the Colorado Supreme Court answered a lingering question about liquidated damages provisions; namely, are they enforceable if the non-breaching party can elect to pursue actual damages instead? The Court said yes. Ravenstar v. One Ski Hill Place, 2017 CO 83.

Liquidated damages are an amount the parties designate in their contract as a reasonable compensation for a specific breach of a contract. To be enforceable, courts typically require that liquidated damage provisions meet three elements: “1) the parties intended to liquidate damages; 2) the amount of liquidated damages, when viewed as of the time the contract was made, was a reasonable estimate of the presumed actual damages that the breach would cause, and 3) when viewed again as of the date of the contract, it was difficult to ascertain the amount of actual damages that would result from a breach.” Id. at ¶ 10 (quotation marks omitted).

The Ravenstar challenge was based on the theory that the parties had not mutually agreed to liquidate the damages, as is required, because the election of liquidated damages was left to one party after the breach occurs. Id. at ¶ 18. Instead, the argument went, such a liquidated damages provision becomes an unenforceable penalty because a non-breaching party will elect liquidated damages only when they exceed actual damages and thereby include a penalty. Id. The Court rejected the challenge and pointed out that a non-breaching party may elect liquidated damages in many instances where actual damages exceed the liquidated damages, or it is uncertain whether they do. Id. at ¶ 20. The non-breaching party may for example choose liquidated damages for certainty and reduced cost of discovery and litigation rather than a potentially greater actual damages claim. Id. at 21. Consequently, a liquidated damages clause is not unenforceable merely because it allows the non-breaching party to choose between liquidated or actual damages after the breach. Id. at ¶ 15.

Importantly, however, the Court clarified that liquidated damages provisions that allow the non-breaching party to elect whether to seek liquidated or actual damages may not allow the non-breaching party to seek both. Id. at ¶ 16. The chosen remedy must be the exclusive remedy. Id. Otherwise, the liquidated damages provision becomes an unenforceable penalty. Id.