A local company recently brought me a Complaint that had been served upon them, and they asked me to review and counsel them on the same.
The Complaint was brought by a towel and uniform service with whom the client had recently contracted. It alleged in relevant part that my client had breached the parties agreement for toweling services by failing to remit timely payment owed for the last month of services provided. The Complaint seemed fair enough. However, the Complaint prayed for damages in the amount of $14,515!! How could this be? Were the uniforms and towels they provided weaved with gold or pixy dust?
I asked my client to send me the underlying agreement between the parties so I could figure out how on Earth one month's worth of simple services gave rise to such disproportional damages.
Well, as it turns out, my client signed a four year agreement (mistake number one) with the Plaintiff and the terms of that agreement included a ridiculous "stipulated" damages clause that essentially allowed the Plaintiff, upon the event of breach, to claim damages in an amount equal to one-half of its usual monthly invoices on the account multiplied by the number of months remaining for the term of the agreement. And since the ridiculously lengthy agreement was only in its fourth month, the Plaintiff Complaint asked for damages equal to 22.5 months worth of service charges (the original unpaid month in the full amount plus one-half month's charges for every remaining month)! .
Unfortunately for the Plaintiff, under our English common law system, one is allowed to collect "damages" for the breach of an agreement, but one is not allowed to collect "penalties". Why? Because if the court's allowed for stipulated penalties that exceeded real damages, then a party would be better off hoping the other party would breach the agreement than it would be if the agreement were kept. That would be an absurd state of affairs.
That was what we had in the instant case. Had the "Stipulated Damages" clause been upheld, then the toweling service would have benefited far beyond the amount it was actually damaged by the client's breach. Here's why. If the agreement had been fulfilled, the toweling service have had to perform the services, but it have only been entitled to the agreed payment. If the stipulated damage clause were upheld, then upon breach, the toweling service was no longer obliged to perform, freeing it to benefit from being able to perform services for a substitute client, while at the same time it would reap the benefit of 43 half-month payments for work that it never had to perform. It could have its cake and its meal!
Indeed, at trial we brought evidence showing as much. And in response thereto, the Court refused judgment for any amount above the actual damages suffered as a result of my client's breach.
The lesson to be learned from this story is twofold. One, you should rarely sign any service agreement that obligates you to a term of more than 12 months. If you are satisfied with the service after one year, you can renew for another year. Its almost never to your company's advantage to have it locked into any obligation that stretches out longer than that.
Secondly, if you or your company is in the habit of signing agreements without professional review, beware of clauses labeled either "liquidated damages" or "stipulated damages". Companies often include these on their standard form agreements without explaining their consequences to the prospective customer. You should never obligate your company to pay any amounts that are outside the reasonable amount of foreseeable damages.