When thinking about liquidated damages, most people focus on the fact that a properly drafted liquidated damages provision will enable the non-breaching party to recover a set amount without ever having to prove how much, if any, actual damages were incurred. What people often forget to consider, however, is that a liquidated damages clause also sets a ceiling for damages.

In K.G.M. Custom Homes, Inc. v. Prosky, the plaintiff prevailed on a breach of contract claim against the defendants when their counsel engaged in conduct that prevented KGM from closing on the purchase of real estate that it had contracted to buy from them. As a result, KGM was awarded $375,000 in damages, the liquidated amount called for by the purchase and sale agreement if the Proskys did not complete the transaction.

While KGM’s case against the sellers was still pending, it brought an independent action against the Proskys’ attorney, Peter Clark. In that action, KGM sought to have Attorney Clark held individually liable for scuttling the transaction and were seeking over $2.8M in lost profits damages. KGM v. Clark eventually settled, with Clark agreeing to pay KGM $595,000 in exchange for a general release.

After Clark paid KGM the $595,000 settlement amount, KGM sought to collect the $375,000 in liquidated damages it was owed by the Proskys. The Proskys challenged KGM’s ability to collect based on the “one satisfaction” rule, which holds that:

Where multiple claims are for “[c]ommon damages stemming from an indivisible harm … a party ‘can have but one satisfaction for the same injury.’”

KGM argued that there would not be a double recovery if it was allowed to collect on its judgment against the Proskys because the monies it received from Clark were lost profits, not liquidated damages. KGM also argued that in settling with Clark, the KGM-Clark settlement agreement expressly stated that:

[N]othing in this agreement shall be construed to release any of the claims asserted in, or in any other way affect or impact, the matter [of] K.G.M. Custom Homes, Inc. v. Stephen Prosky….

The Superior Court quickly dispensed with this latter point, noting that the reservation language could not impact the Proskys’ rights or obligations because they were not parties to the KGM-Clark settlement agreement. Further, as for the application of the one satisfaction rule, the Superior Court said that:

KGM and the Proskys explicitly agreed that in case of a breach of contract by the Proskys, KGM’s loss would be calculated under the liquidated damages provision in their contract. It would be inequitable to allow KGM to ignore the agreement it freely made or to deny the Prosky’s the benefit of the provision for which they bargained.

While KGM is interesting for a number of reasons, one key aspect of it is that it affirms the notion that a liquidated damages clause is not solely designed to protect the non-breaching party. Such provisions also can provide comfort, and protection, to a party who has breached (or is considering breaching) an agreement by capping the financial exposure. Thus, in addition to the negotiating and drafting tips I previously have offered, in-house counsel also should keep in mind that liquidated damages can be viewed as a limitation on liability that courts will enforce.