Liquidated damages provisions in non-consumer contracts are deemed valid unless the party seeking to invalidate the provision establishes that the provision was unreasonable under the circumstances existing at the time the contract was made. See Civil Code section 1671 (b).
Liquidated damages generally refer to a fixed amount of compensation to be paid in the event of a breach of contract. The sum of the compensation is agreed upon by the parties and stated in the contract. This post discusses the California Court of Appeal’s recent decision in Gormley v. Gonzalez (Case No. C093201, Oct. 12, 2022), which provides helpful guidance regarding how to draft an enforceable liquidated damages provision under California law.
The Liquidated Damage Provision in Gormley
Gormley involved plaintiffs in 20 separate medical malpractice lawsuits who settled their claims with two doctors and a medical facility through a global settlement agreement. The agreement required the defendants to pay the plaintiffs a total of $575,000, payable in two installments. The agreement further provided that if the installments were not timely paid, liquidated damages would be assessed at the rate of $50,000 per month, prorated at $1,644 per day, up to a cap of $1.5 million.
The defendants failed to pay the first installment, so the plaintiffs filed a motion to enforce the settlement agreement, including the liquidated damages provision, pursuant to California Code of Civil Procedure section 664.6. The defendants opposed the motion, arguing briefly and without citing any evidence that the liquidated damages provision was unreasonable because the plaintiffs would not suffer such damage due to the delayed payment. The trial court found the contractually agreed upon amount to be reasonable under the circumstances and, therefore, entered judgment against the defendants in the amount of $1,393,084 (the settlement amount of $575,000 plus $818,084 in liquidated damages). The defendants appealed.
The Amended Section 1671 Favors Enforcement
California law has long addressed the validity of liquidated damages provisions in contracts. Former section 1670, enacted in 1872, provided a liquidated damages provision was “void” unless it complied with former section 1671. The current Civil Code section 1671 was amended in 1977. The substance of the section essentially remains the same as to consumer contracts. But for non-consumer contracts like the settlement agreement in Gormley, subdivision (b) of section 1671 created “a new general rule favoring the enforcement of liquidated damages provisions.” That rule provides:
[A] provision in a contract liquidating the damages for the breach of the contract is valid unless the party seeking to invalidate the provision establishes that the provision was unreasonable under the circumstances existing at the time the contract was made.
Accordingly, in cases involving a liquidated damages provision in a non-consumer contract, the burden of proof rests with the party seeking to invalidate the provision.
The Gormley court made clear the appropriate test for lower courts when determining whether a particular liquidated damages provision is “reasonable.” The court must consider “all the circumstances existing at the time of the making of the contract.”
With the appropriate test established, the Gormley court analyzed the liquidated damages provision in the subject settlement agreement as follows. First, both sides were represented by counsel during the settlement negotiations, and several drafts of the agreement were exchanged before its terms were finalized. Indeed, counsel for both parties signed the settlement agreement to indicate that they had approved it. Second, the parties agreed that a reasonable estimate of the total verdicts had all the cases gone to trial was $1.5 million. Although the defendants made assurances that they had money immediately available to pay the first installment, the plaintiffs were (rightfully) worried that the defendants would not pay the second installment. This is why they negotiated the liquidated damages provision (and allowed the trial court to maintain jurisdiction to enforce the settlement agreement). As incentive to pay the installments as agreed, the parties agreed on liquidated damages in an amount not to exceed the full value of $1.5 million. Considering all of the circumstances, the court held that the defendants failed to meet their burden to demonstrate that the liquidated damages provision was unreasonable.
In drafting a liquidated damages provision to be included in a non-consumer contract under California law, parties must consider whether a court would likely find the provision to be reasonable under all the circumstances. But as the Gormley court also pointed out, in its interpretation of a binding decision, Ridgley v. Topa Thrift & Loan Assn. (1998) 17 Cal.4th 970, 977:
We are not convinced that Ridgley creates a rule that allows a defendant in a lawsuit—particularly one who is represented by counsel—to actively negotiate a settlement agreement with a liquidated damages clause (and thus to effectively halt the plaintiff’s prosecution of the case), to default on that agreement, and then to resist entry of judgment by arguing the clause is invalid because the damages it agreed to are too high. Put another way, we are not convinced that Ridgley creates a rule that allows represented defendants to assert what might be called the “hey neener neener, gotcha sucker” defense.
The primary consideration, it seems based on the Gormley decision, is whether the agreed upon liquidated damages provision has some reasonable relationship to actual damages. It would serve parties well to discuss this point and expressly include discussion of it in the contract containing the liquidated damages provision. Other factors, like counsel being involved in negotiations (and signing the contract) will also help to ensure enforceability.
Under Gormley, California courts are likely to find more liquidated damages provisions enforceable than in the past. As the Court of Appeal ended the decision, “[w]e find nothing unreasonable about holding Defendants to the price they agreed to pay for failing to keep their promise.” And after all, that is the whole idea behind liquidated damages.
If you have questions or comments on the content of this post, please email Sara Borjigin at [email protected].
 The decision was rendered by the Third District Court of Appeal, which sits in Sacramento.
 This makes the case easily distinguishable from Greentree Financial Group, Inc. v. Execute Sports, Inc. (2008) 163 Cal.App.4th 495, and Vitatech Internat., Inc. v. Sporn (2017) 16 Cal.App.5th 796 (two cases the defendants relied on) because the uncontradicted evidence in the record is that the parties agreed $1.5 million was a reasonable estimate of the total verdicts plaintiffs would have recovered had their cases gone to trial, which is why they capped liquidated damages at that amount. The court also noted in a footnote that they might feel differently if the liquidated damages were not capped such that the defendants faced liability far in excess of what they would have faced had they gone to trial.Back to KF&C Law Blog