A liquidated damages provision in a franchise agreement is an important tool for a franchisor to ensure that it will be contractually and adequately compensated in the event its franchisee breaches. While liquidated damages provisions are commonly used in hotel franchise agreements, such provisions are not necessarily enforceable. A franchisor should take due care with respect to these provisions to increase the likelihood of their enforceability. A recent case involving a hotel franchise in Maryland provides guidance regarding the factors a court will consider when determining the enforceability of a liquidated damages provision in a franchise agreement.
In Choice Hotels International, Inc. v. Smith Hotel Properties, LLC, No. 5:09-CV-00285-80 (E.D.N.C. May 6, 2011), Choice Hotels sued Smith Hotel for breach of its franchise agreement and sought summary judgment on the liquidated damages provision in the franchise agreement. The trial court denied summary judgment, but that ruling was reversed and summary judgment on liquidated damages was granted upon a motion for reconsideration. The relevant provision in the franchise agreement was as follows:
If we terminate this Agreement due to your default after the Opening Date … you will pay us, within 30 days after termination, as liquidated damages and not as a penalty for the premature termination, the product of (i) the average monthly Gross Room Revenues during the prior 12 full calendar months (or the shorter time that the Hotel has been in the system), multiplied by (ii) the Royalty Fee (as defined below), multiplied by (iii) the number of months until the next date that you could have terminated this Agreement without penalty (“Remaining Months”), not to exceed 36 months. However, the product of (i) multiplied by (ii) will not be less than the product of $40.00 multiplied by the Rentable Rooms.
The court considered three factors when determining the enforceability of this type of liquidated damages provision under Maryland law: (1) the contract must identify a mechanism so that, at the time of the breach, a specific dollar amount can be determined; (2) the amount of damages must be reasonable in comparison to the amount of damages anticipated to be incurred as a result of the breach; and (3) the amount of damages may not be altered after the fact to cover the actual damages incurred as a result of the breach. The court decided that, because there was a specific calculation that determined the exact amount of damages at the time of the breach, such damages were not “grossly excessive and out of all proportion,” and because the amount of damages resulting from the calculation was final and binding, Choice Hotels should be granted its motion for summary judgment for damages in the amount of $158,400.00.
Liquidated damages provisions are a convenient remedy for hotel franchisors in the event their franchise agreements are breached. As such, it is important to comply with the factors above to get the benefit of such a provision.