Liquidated damages and penalties - Next Generation Bar Exam

1. Under the Restatement (Second), when is a liquidated damages clause enforceable?

   When the amount is reasonable in light of the anticipated or actual loss and the difficulty of proving loss. Reasonableness may be measured either at formation or by the loss actually caused.

2. A construction contract sets damages of $500 for each day of delay, and the owner's expected rental loss is about $450 per day. On what ground is the clause enforceable?

   It is a reasonable forecast of loss that would be difficult to prove precisely. The stipulated amount is close to the anticipated harm, so it compensates rather than punishes.

3. What weight does the parties' label of 'liquidated damages' or 'penalty' carry?

   Little; courts examine the substance of the clause. A clause called liquidated damages will still be struck if it operates as a penalty.

4. Why is a single fixed sum payable for any breach, however minor, often treated as a penalty?

   It cannot be a reasonable forecast of loss for both trivial and serious breaches. Courts call this a shotgun clause and infer that it was meant to coerce performance rather than estimate loss.

5. A contract requires a $100,000 payment for any late payment of a $1,000 invoice. What may the creditor recover for a one-week delay?

   Only its actual damages, because the clause is an unenforceable penalty. The stipulated sum bears no reasonable relationship to any foreseeable loss from the delay.

6. When a liquidated damages clause is valid, what may the injured party recover if its actual loss proves greater?

   The stipulated amount only. A valid liquidated damages clause binds both parties, whether the actual loss proves larger or smaller.

7. Absent a valid liquidated damages clause, how much of a breaching buyer's down payment may the seller keep under UCC 2-718(2)?

   The lesser of 20 percent of the price or $500. The buyer may recover the excess, subject to the seller's right to prove greater actual damages.

8. Under UCC 2-718, what factors determine whether liquidated damages are reasonable?

   Anticipated or actual harm, difficulty of proving loss, and the inconvenience or infeasibility of another remedy. The UCC test parallels the common-law test but adds the adequacy of other remedies.

9. What is the effect of a clause the court finds to be a penalty?

   It is unenforceable, and the injured party recovers its actual damages. Contract law compensates for loss; it does not punish breach.

10. Under UCC 2-718, what is the effect of an unreasonably large liquidated damages term?

    It is void as a penalty. The UCC states expressly that an unreasonably large amount is void.

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