The obvious purpose of a liquidated damages provision is to make your client whole in the event that your business partner breaches the agreement. Nevertheless, K.G.M. Custom Homes. v. Prosky highlights that simply having a valid and enforceable liquidated damages provision is not enough to ensure this.

In K.G.M., the plaintiff contracted to buy real estate in order to develop single family homes. Unlike more standard such transactions, however, (i) the closing was not to take place until 21 days after K.G.M. received permits and approvals to develop the property, and (ii) the purchase price was to vary depending upon how many lots K.G.M. was approved to develop. Thus, it was contemplated that K.G.M. was going to have to expend a significant amount of time, money and/or other resources before it ever would be in a position to close on the transaction. In light of this, it made perfect sense for the purchase and sale agreement to include a liquidated damages provision stating that if the seller breached, it:

[S]hall pay [K.G.M.], as liquidated damages, a sum of money equal to all charges and fees paid by [K.G.M.] in connection with this transaction, including but not limited to, attorneys’ fees.

Six years later, and after K.G.M. had incurred $375,000 towards the transaction, the time for closing finally had arrived. However, in breach of their obligations under the purchase and sale agreement, the sellers refused to close and K.G.M. sued. K.G.M. prevailed at trial and was awarded liquidated damages in the amount of $495,000, $375,000 in out-of-pocket expenses, and $120,000 in attorneys’ fees associated with the litigation.

K.G.M. appealed the judgment, and the finding of liability, as well as the award of out-of-pocket expenses, were affirmed. As for the award of attorneys’ fees, however, the Supreme Judicial Court stated:

On its face, the [liquidated damages] clause appears to contemplate only attorney’s fees incurred in connection with the transfer of the land, which would include the process of securing approval from the necessary authorities. Tellingly, the provision benefits only K.G.M., as there is no provision providing for the recovery of attorney’s fees connected with any litigation for a breach by K.G.M. Thus, where the plain language of the agreement does not contemplate the awarding of attorney’s fees for litigating its breach, the judge’s decision represented a windfall for K.G.M., which goes against the intent of the American Rule [which Rule provides that each side bears its legal fees in litigation, win or lose].

So the next time you contemplate including a liquidated damages provision in a contract, don’t forget to include a companion provision that expressly allows for the recovery of legal fees if you are required to sue for breach. Failing to do so could result in your client ending up far short of being made whole.