Official Blog of Kent Maynard & Associates

Everybody remembers liquidated damages from law school.  The parties to a contract agree, at the outset, that damages flowing from a breach will be hard to ascertain.  Accordingly, to avoid a costly fight in the future, they agree to a dollar amount of “liquidated damages” as their best (good faith) “guesstimate” of what the actual damages will be.  Then, when a breach occurs, somebody gets that amount, without a lot of fuss.  Simple, right?  Wrong.  What you don’t know about liquidated damages could, in the context of a real property sale (and escrow), cost you big money.

Suppose that you are the seller of real property.  Suppose further that the sale is closed while a contingency (such as a rezoning) is pending that could substantially increase the value of the property.  Suppose finally that the parties agree to escrow part of the sale consideration, to be returned to buyer in the event the contingency is not realized.  The parties pick a date that appears to permit ample time for the contingency to be definitively  realized — or not.  They think, “If the contingency hasn’t happened by such date, then it seems certain that it won’t be realized at all.”

But they are wrong.  The contingency is realized a few weeks after after the specified date has passed.  Buyer demands the escrow amount.  Seller objects, pointing out that buyer got the (long-term) value of the contingency, albeit subject to a short (and immaterial) delay.  Seller further points out that buyer has not suffered any quantifiable damage from the delay.

Who gets the escrow?  More to the point, does buyer get the escrow because it may be properly construed as “liquidated damages” for seller’s breach?

That is what the trial court found in GK Development, Inc. et al. v. Iowa Malls Financing Corp., Case No. 06 CH 03427, a case that is now on appeal and fully briefed in the First District Appellate Court (as Appeal 1-11-2802).

In our opening brief and reply brief, we argued that to be enforceable under Illinois law, liquidated damages must be a good-faith prediction of damages that might flow from a breach, and not be punitive in nature.  We argued that forfeiture of the escrowed amount might make sense for a complete failure of the contingency, but forfeiture of the escrow could not be justified as a reasonable prediction of damages from a short delay.  Buyer contended that the trial court’s ruling was entitled to deference on appeal, because it was necessarily based on findings of fact.

We believe that Illnois courts do not enforce “liquidated damages” that are not reasonably connected to actual damages.  We further believe that an escrow amount established in respect of the complete failure of a contingency cannot be awarded as “liquidated damages” for mere delay.  Suffice it to say here that more details will follow, when the First District decides the issues presented.

In the meantime, if you are selling real property subject to an escrow, be sure that the contract carefully defines the nature of the escrow, to ensure that the escrow amount cannot be construed as a Draconian penalty — in the guise of liquidated damages – for an inconsequential delay. 

If you have a related — or unrelated — concern or need advice concern an appeal please call Kent Maynard at 312 423 6586.

UPDATE as of November 10, 2013:

The Fourth Division of the First District Appellate Court heard oral argument in this case on September 5, 2013. You can listen to a recording of the argument by clicking HERE.

We will share a copy of the Court’s decision when it is handed down.

-KM

UPDATE as of December 22, 2013:

Last week the First District Appellate Court issued its Opinion in GK Development, Inc. et al. v. Iowa Malls Financing Corp.; Appeal 11-2802. The Court reversed the trial court’s finding that a forfeiture of $4.3 million placed in escrow was justified as an award of liquidated damages for breach of contract — an award that we sucessfully contended was an unenforceable penalty for a transitory and inconsequential breach. A copy of the Opinion, which will be published by the First District, can be viewed HERE. It would be an understatement to say that we were heartened by the Court’s closely-reasoned Opinion, which comes just in time for the holidays.

Further UPDATE as of February 10, 2014:

The Chicago Daily Law Bulletin published an article about the First District’s December 22, 2013 decision on its front page on February 10, 2014. It can be viewed HERE. Unfortunately, the article appears to overlook a footnote in the Opinion. That footnote states, in pertinent part, “. . . it appears that Buyer did not suffer any ‘lost’ rent as the 20-plus-year lease was merely pushed back 91 days. Buyer will still receive the entire profit anticipated from the 20-year lease.” There is, as the Court noted, no lost rent — only, at most, a delayed onset of increased rent.

-KM

Further UPDATE as of March 10, 2014:

Will this litigation never end? On February 24, 2014 Appellees (Buyer) filed a Petition for Leave to Appeal to the Illinois Supreme Court. It can be viewed HERE. The PLA invokes Adam Smith and Milton Friedman to argue that Illinois should abandon the Second Restatement approach to enforcement of liquidated damages, as summarized in the Jameson case. Today we filed on behalf of Seller an Answer wherein we point out that it was only after the First District found that the trial court’s award of “liquidated damages” did not pass muster under Jameson that Buyer first complained that Jameson was “outmoded” and “paternalistic.” Our Answer can be viewed HERE.

We will report as to how the Illinois Supreme Court rules on the PLA in due course.

In 2006, Mary Tujetsch, the purchaser of a dental practice, brought a civil action against our client, Dr. Todd Pusateri.  In a three-count  amended complaint, Tujetsch alleged that she had not received all the “active patients” she bargained  for in the purchase.

The parties’ asset purchase agreement recited that the practice had approximately 1,200 “active patients,” as reported by First Pacific Corporation dental practice management software.  Tujetsch alleged that she had not received that number of “active patients” because a review of patient charts conducted months after the sale suggested that some patients had moved, declined treatment, or declined to schedule appointments, among other things.  Tujetsch asserted that such patients were not “active patients” — based on her alleged subjective understanding of the term “active patients” — even if they had been treated in the 24 months before the sale, as reported by First Pacific dental practice management software.

In a motion for summary judgment, we argued, on behalf of Dr. Pusateri, that “active patients” is a dental term of art that refers to the number of patients treated in a dental practice during a defined lookback period, usually 12, or 24 months.  We argued both in the trial court and on appeal that that this definition is consistent with the ADA definition of “active patient,” and the definition of “active patient” employed by First Pacific Software, which is widely distributed throughout the United States — and defines “active patient” as any patient treated in the previous 24 months, without regard to other events.  As such, the number of “active patients” is an objective tally, and says nothing about changes in the status of a patient after receiving treatment.

In June 2011, Judge Raymond Mitchell Mitchell entered an Order granting summary judgment to Dr. Pusateri on all counts of the complaint filed by Tujetsch.  Judge Mitchell found there had been no misstatement of “active patients,” properly understood, because there was no evidence that Dr. Pusateri misstated the number of patients treated in the practice,  in the 24 months before the sale, as reported by First Pacific software.

Tujetsch took an appeal of Judge Mitchell’s order to the First District Appellate Court.

On July 20, 2012, the First District issued an Order upholding Judge Mitchell’s June 2011 Order in its entirety.  Among other things, the Order states that evidence from disinterested third-parties about the meaning of contract terms is preferred over subjective (and self-serving) definitions offered by the parties to a dispute.