by Anna Wang, Legal Researcher at Shake
Sometimes, a person or company you have a contract with might cancel the agreement early for reasons that aren’t your fault. Your contract should lay out what to do in these sorts of sticky situations. Let’s look at how a contract can protect you in the event of early termination.
Damages: Getting Paid
A deal is a deal – when you and another party enter into a contract, the legal expectation is that you’ll both carry it out unless you mutually agree to change it.1 The party that’s been the victim of a broken deal is entitled to a remedy, which most commonly comes in the form of damages (money). Damages can be calculated under various theories,2 but the overall goal is to return you to the position you were in prior to entering the contract and compensate you for the loss you’ve suffered.
Damages are Not a Way to Punish the Other Party (Sorry)
If you’ve suffered no loss (e.g., if you haven’t started the work specified in a contract) or you can’t prove the amount of the loss you’ve suffered, the most you’re legally entitled to is nominal damages (a small amount of money).3 Damages are designed to make you whole, not to punish the other party — unless the breach in contract is also a tort, in which case punitive damages are available.4
Sadly, the other party being a jerk and causing you mental aggravation does not count as a tort.
Plan Ahead in Your Contract
Your contract should spell out what will happen if the other party terminates the agreement without cause. One approach is to clearly state that you must be paid for the work completed up to the termination. This can be a good choice when it’s easy to calculate the value of the work you’ve completed (for example, if you’re working on an hourly basis) or if you’ve staggered your project into phases.
Another approach is to specify that you will be owed liquidated damages,5 a set amount specified in the contract. Liquidated damages are sometimes referred to as a “kill fee” and can be a good approach when it would be hard to measure the value of the work completed at termination. But liquidated damages should not be set too high or too low. Too high, and they might be found punitive and therefore unenforceable.6 Too low, and they won’t adequately compensate the non-breaching party.7 That said, you don’t need to be scientifically precise in setting liquidated damages — the liquidated damages you specify just need to be reasonable relative to the probable damage.8
- Contracts are legally binding, so you have legal recourse and may be able to collect damages if the other party cancels.
- Two options for specifying in a contract how you will be paid in the event of termination are to state that you will be owed for work completed at the time of termination, or that you will be entitled to pre-set liquidated damages.
- Damages cannot be punitive, so if you choose to specify liquidated damages, the amount you set out should be reasonably related to damage you anticipate in the event of termination.
- Specify in your contract how much your client will owe you for early termination. If using liquidated damages, then state the specific amount. If you’ll be compensated for the work completed, specify how you will calculate that.
- If your contract provides for liquidated damages, it is a good idea to specify in the agreement what costs or losses that fee is intended to cover. This will help prevent claims that the damages are punitive.
- In a contract for a project, consider dividing the project into phases and tying damages to those stages. For instance, if a party paying you for a three-phase project cancels after phase two, specify that the party will owe you for the two completed phases.
- If a contract involves payment to you, ask for part of your payment upfront, since it’s always easier to keep money than to collect it. It can also help gauge how serious the other party is about the project.
- There are exceptions to the rule of a party needing to hold up its end of a deal, such as when one party materially breaches the agreement. ↩
- Direct damages are damages someone with no specialized knowledge would expect at the time of entering the contract (e.g., if steel beams turned out to be defective and caused the roof of a building to collapse, the cost of the repair of the roof would be direct damages, because it’s clear from the outset that a roof collapsing is a reasonable consequence of defective support beams in any situation). Incidental damages are damages reasonably related to direct damages (e.g., your efforts to avoid loss from the breach, such as the costs involved in finding other avenues to sell your work). Consequential damages are damages that were foreseeable by the parties at the time they entered the contract, but not of the sort you’d expect of the type of breach (e.g., at the time of contract, the contracting parties knew that the contracted piece would be entered as part of an installation, and there was another contract that stipulated a penalty if that piece was not part of the installation). Restatement (Second) of Contracts § 347 (1981). ↩
- Id. § 346 (1981). ↩
- Id. § 355 (1981). ↩
- See Black’s Law Dictionary (9th ed. 2009), liquidated damages (“If the parties to a contract have properly agreed on liquidated damages, the sum fixed is the measure of damages for a breach, whether it exceeds or falls short of the actual damages.”). ↩
- See Muldoon v. Lynch, 66 Cal. 536, 539, 6 P. 417 (1885) (liquidated damages are not valid when parties intend on the face of the contract for them to serve as a penalty). ↩
- See Samson Sales, Inc. v. Honeywell, Inc., 465 N.E.2d 392, 394 (1984) (liquidated damages that are set at a nominal amount are punitive, since the non-breaching party isn’t being reasonably compensated for the harm suffered). ↩
- See Kothe v. R.C. Taylor Trust, 280 U.S. 224, 226 (1930) (stating that courts are inclined to carry out the will of contracting parties, but liquidated damages that have no reasonable relation to probable damage will not be enforced). ↩