Lease Agreements: Understanding Liquidated Damage Provisions Vs. Penalties

Liquidated damages are fixed damages that the contracting parties designate during the formation of a contract. This pre-determined amount for damages is triggered by a breach of the contract; designed to make the non-breaching party whole.

The State of Idaho recognizes the contracting parties’ right to pre-determine damages if a breach of the agreement were to happen. However, the courts will not enforce a liquidated damages provision that is deemed a penalty. So, what’s the difference between an enforceable liquidated damages provision and a penalty?

A liquidated damages provision is enforceable if: (1) the circumstances make it difficult or impossible to determine actual damages, and (2) the liquidated damages provision the parties agreed to bear a reasonable relation to the non-breaching party’s actual damages. On the flip side, the liquidated damages provision is a penalty if the fixed damages are: (1) arbitrary and do not bear a reasonable relation to the non-breaching party’s actual damages, and (2) exorbitant and unconscionable. The courts will not enforce a liquidated damages provision if the provision is deemed a penalty. This position has recently been reaffirmed in Melaleuca, Inc. v. Foeller, 155 Idaho 920 (2014).

Liquidated damages provisions are prevalent in lease agreements. The following is an example of a liquidated provision in a lease agreement:

LATE FEES. There shall be a $100.00 late fee for rent received after the 5th day of the month. Commencing on the 10th day of the month, an additional fee of $10.00 per day will accumulate until all monies are received.

On its face, there does not appear to be anything wrong with this provision. By signing the lease agreement, the tenant has agreed to pay rent on time. If the tenant fails to comply with the payment terms, the tenant should have to pay additional funds because that is what it agreed to do.

Often, a tenant will either pay its rent on time or pay the fixed damages outlined in the liquidated damages provision without question. However, it is possible that a tenant fails to pay its rent, incurs the late fees, and then argues the provision is a penalty when the landlord sues the tenant for the recovery of past due rent and late fees.

If this happens, the tenant is required to show the fixed damages are unconscionable, do not bear any relation to the landlord’s actual damages, and are designed to punish the tenant for breaching the lease as opposed to making the landlord whole. In response, the landlord must show why the provision is not a penalty. In other words, that the actual damages were difficult to determine at the time of the lease agreement and that the pre-determined damages were reasonable compared to the actual damages the landlord suffered because of the tenant’s breach.

The enforce-ability of a liquidated damages provision is very fact-specific.

Please contact our office should you have any questions regarding liquidated damages provisions or other-related matters.

Contact A Real Estate Attorney At Brian Webb Legal By Calling (208) 331-9393