Think Twice Before Using a Liquidated Damages Clause

May 4, 2016

NC courts generally give broad deference to parties entering into a contractual relationship to negotiate the terms of the contract, including legal remedies against each other.  One type of remedy which may be included is a liquidated damages clause.  Such a provision provides a pre-determined amount that a breaching party will owe the non-breaching party in the event of a breach.  This contractual provision has both positives and negatives.  On the one hand, it will typically be cheaper to negotiate the liquidated damages clause on the front end, as opposed to resolving the issues of damages in subsequent litigation. On the other hand, issues of the provision’s enforceability can, of course, be litigated and get very expensive.  Further, agreed upon damages at the time the contract was executed may prove insufficient at the time of a breach.

Can an attorney include a liquidated damages clause in a fee agreement with a client?  There does not appear to be any North Carolina ethics opinions or rules that expressly prohibit it.  Using such a provision, however, seems to force commercialism into the arrangement and ignores the heart of the attorney-client relationship — a relationship based on duty and trust.  Including such a provision also seems to be at odds with the fact that a client may terminate the services of an attorney at any time and for any reason.   Moreover, from a practical standpoint, clients may not appreciate these clauses, and wonder why an attorney would include the provision in a fee agreement. This provision may send the wrong message and a client may decide to go elsewhere.

Listed below are a few other considerations (but certainly not all) that weigh against using these provisions:

  • A liquidated damages clause in a fee agreement may not result in a clearly excessive attorney fee.
  • Contract provisions, to be ethical, must also be lawful.  I have not found any NC law which would indicate that such a provision in a NC fee agreement would be unlawful or against public policy.  However, this is a relatively new area. In service or consumer contracts, as opposed to employment contracts, there is not much law on whether a service provider may include this kind of language in their contracts.  You will need to keep up-to-date on this emerging area.
  • Liquidated damages provisions will generally be construed against the attorney, to the extent there is any question about interpretation.  The attorney is in a position of trust, and the attorney and the client do not have equal bargaining power. The courts will likely find the client was not given meaningful opportunity to negotiate the terms of the contract.
  • It is also important that you are certain that the client is specifically aware of this contractual provision, so that you would be able to state that the client knowingly forfeited this right if ever challenged on the provision.
  • Finally, a liquidated damages clause cannot amount to a penalty, and it is hard to see how a liquidated damages clause in your ordinary attorney fee contract could be anything else. The NC Supreme Court notes, “It is well established that a sum specified in the contract as the measure of recovery in the event of a breach will be enforced if the court determines it to be a provision for liquidated damages, but not enforced if it is determined to be a penalty.”  Brenner v. Little Red School House, Ltd., 302 N.C. 207,214, 274 S.E.2d 206, 211 (1981).

All this is to say, it is better not to treat your client fee contract like an ordinary commercial transaction.  While you can adequately protect yourself in the event of a breach by having a written fee contract, keep in mind that your fee contract is the first step in setting the tone of your relationship with your client.   It shouldn’t start out by being an adversarial one.

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