Everybody remembers liquidated damages from law school. The parties to a contract agree, at the outset, that damages flowing from a breach will be hard to ascertain. Accordingly, to avoid a costly fight in the future, they agree to a dollar amount of “liquidated damages” as their best (good faith) “guesstimate” of what the actual damages will be. Then, when a breach occurs, somebody gets that amount, without a lot of fuss. Simple, right? Wrong. What you don’t know about liquidated damages could, in the context of a real property sale (and escrow), cost you big money.
Suppose that you are the seller of real property. Suppose further that the sale is closed while a contingency (such as a rezoning) is pending that could substantially increase the value of the property. Suppose finally that the parties agree to escrow part of the sale consideration, to be returned to buyer in the event the contingency is not realized. The parties pick a date that appears to permit ample time for the contingency to be definitively realized — or not. They think, “If the contingency hasn’t happened by such date, then it seems certain that it won’t be realized at all.”
But they are wrong. The contingency is realized a few weeks after after the specified date has passed. Buyer demands the escrow amount. Seller objects, pointing out that buyer got the (long-term) value of the contingency, albeit subject to a short (and immaterial) delay. Seller further points out that buyer has not suffered any quantifiable damage from the delay.
Who gets the escrow? More to the point, does buyer get the escrow because it may be properly construed as “liquidated damages” for seller’s breach?
That is what the trial court found in GK Development, Inc. et al. v. Iowa Malls Financing Corp., Case No. 06 CH 03427, a case that is now on appeal and fully briefed in the First District Appellate Court (as Appeal 1-11-2802).
In our opening brief and reply brief, we argued that to be enforceable under Illinois law, liquidated damages must be a good-faith prediction of damages that might flow from a breach, and not be punitive in nature. We argued that forfeiture of the escrowed amount might make sense for a complete failure of the contingency, but forfeiture of the escrow could not be justified as a reasonable prediction of damages from a short delay. Buyer contended that the trial court’s ruling was entitled to deference on appeal, because it was necessarily based on findings of fact.
We believe that Illnois courts do not enforce “liquidated damages” that are not reasonably connected to actual damages. We further believe that an escrow amount established in respect of the complete failure of a contingency cannot be awarded as “liquidated damages” for mere delay. Suffice it to say here that more details will follow, when the First District decides the issues presented.
In the meantime, if you are selling real property subject to an escrow, be sure that the contract carefully defines the nature of the escrow, to ensure that the escrow amount cannot be construed as a Draconian penalty — in the guise of liquidated damages – for an inconsequential delay.
If you have a related — or unrelated — concern or need advice concern an appeal please call Kent Maynard at 312 423 6586.
UPDATE as of November 10, 2013:
The Fourth Division of the First District Appellate Court heard oral argument in this case on September 5, 2013. You can listen to a recording of the argument by clicking HERE.
We will share a copy of the Court’s decision when it is handed down.
UPDATE as of December 22, 2013:
Last week the First District Appellate Court issued its Opinion in GK Development, Inc. et al. v. Iowa Malls Financing Corp.; Appeal 11-2802. The Court reversed the trial court’s finding that a forfeiture of $4.3 million placed in escrow was justified as an award of liquidated damages for breach of contract — an award that we sucessfully contended was an unenforceable penalty for a transitory and inconsequential breach. A copy of the Opinion, which will be published by the First District, can be viewed HERE. It would be an understatement to say that we were heartened by the Court’s closely-reasoned Opinion, which comes just in time for the holidays.
Further UPDATE as of February 10, 2014:
The Chicago Daily Law Bulletin published an article about the First District’s December 22, 2013 decision on its front page on February 10, 2014. It can be viewed HERE. Unfortunately, the article appears to overlook a footnote in the Opinion. That footnote states, in pertinent part, “. . . it appears that Buyer did not suffer any ‘lost’ rent as the 20-plus-year lease was merely pushed back 91 days. Buyer will still receive the entire profit anticipated from the 20-year lease.” There is, as the Court noted, no lost rent — only, at most, a delayed onset of increased rent.
Further UPDATE as of March 10, 2014:
Will this litigation never end? On February 24, 2014 Appellees (Buyer) filed a Petition for Leave to Appeal to the Illinois Supreme Court. It can be viewed HERE. The PLA invokes Adam Smith and Milton Friedman to argue that Illinois should abandon the Second Restatement approach to enforcement of liquidated damages, as summarized in the Jameson case. Today we filed on behalf of Seller an Answer wherein we point out that it was only after the First District found that the trial court’s award of “liquidated damages” did not pass muster under Jameson that Buyer first complained that Jameson was “outmoded” and “paternalistic.” Our Answer can be viewed HERE.
We will report as to how the Illinois Supreme Court rules on the PLA in due course.
The PLA was denied ages ago and the case remanded to the trial court.
Almost two years later, the process of litigating those two remanded issues has yet to begin. Why is that so? Because Buyer took the position that Buyer’s claim in a related case that was previously pending should be litigated in the remanded proceeding. When that seemed unlikely, Buyer “re-filed” its so-called “Parking Lot Claims” in a new action (hereinafter “the Parking Lot Case”), and then successfully moved to transfer the case to the same docket as the remanded case. After that claim was dismissed, Buyer appealed and moved to stay the remanded case pending the appeal. The trial court agreed to stay the remanded action in deference to the appeal of the separately filed action. We appealed, on grounds set forth in our opening brief which can be viewed HERE.
We will report on the First District’s response to our appeal of the stay order as soon as a decision is handed down.
First, the First District Appellate Court affirmed the circuit court’s stay of the remanded, post-appeal action pending a decision in the appeal of Buyer’s separate, “re-filed” Parking Lot Claims. The Court’s decision can be viewed HERE.
Second, thereafter the First District Appellate Court AFFIRMED the trial court’s dismissal of the “re-filed” Parking Lot Claims, in a separate re-filed action. The Court relied on Illinois Supreme Court Rule 273 to affirm. Its Opinion can be viewed. HERE.