Client Saves More Than $250,000 as Federal Court Invalidates Unfair Penalty Clause in Settlement Agreement 

The goal of a settlement agreement is for both parties to walk away from a case, if not feeling happy, then at least feeling like they avoided the high costs associated with fully litigating a case. Unfortunately for one Hayes Hunter client, the settlement agreement he signed in a dispute handled by another law firm had a penalty clause of “$2,000 per day” if the client didn’t fulfill his obligations on time. 

The problem presented by the client.

When the client came to Hayes Hunter for help, the other party to the settlement agreement had made it impossible for the client to perform his obligations and astonishingly was demanding payment of the $2000 daily penalty. Hayes Hunter helped the client reopen the settled case and asked the Court to invalidate the penalty clause. 

How we solved it.

Under Texas Law, a settlement agreement is a contract. So, violations of a settlement agreement are treated as a breach of contract entitling the non-breaching parties to legal remedies including damages. If the monetary value of damages is difficult or impossible to calculate, the parties to a contract enforceable under Texas laws can agree an amount of “liquidated” damages to impose on a party breaching the agreement. 

For example, the harm caused by a breach of a confidentiality agreement may be impossible to know or measure. So, parties often agree in confidentiality agreements to “liquidated damages” of a specific amount to compensate for any breach of the agreement.

In Texas, liquidated damages for a breach of contract are allowed only if, from the perspective of the parties signing the contract at the time they were making the contract, both (1) the harm caused by breach of contract is impossible or unreasonably difficult to estimate, and (2) the amount of liquidated damages is a “reasonable forecast” of actual damages. Atrium Med. Ctr., L.P. v. Houston Red C, L.L.C., 595 S.W.3d 188, 192 (Tex. 2020); see FPL Energy, L.L.C. v. TXU Portfolio Mgmt. Co., L.P., 426 S.W.3d 59, 69–71 (Tex. 2014). 

If both prongs of this test are not met, then courts determine the liquidated damages clause is not for liquidated damages at all but is instead a penalty clause and unenforceable under Texas law. Urb. Television Network Corp. v. Liquidity Sols., L.P., 277 S.W.3d 917, 919 (Tex. App. 2009) (citing Phillips v. Phillips, 820 S.W.2d 785, 788 (Tex.1991) (quoting Stewart v. Basey, 150 Tex. 666, 669, 245 S.W.2d 484, 486 (1952))) (“A liquidated damages provision is enforceable and is not a penalty when the damages are uncertain and stipulated damages are reasonable.”).

The settlement agreement required the client to pay $2,000 per day if he did not put $150,000 into a real property escrow account by a certain date. However, the other party refused to provide a payoff amount on the underlying real estate loan making it impossible for the client to close the deal. 

Despite its lack of cooperation, the other party claimed entitlement to the $2000 daily penalty.  Multiplied over 365 days in one year, the settlement agreement would have allowed potential penalties of $730,000—the equivalent of nearly 487% annual interest on the principal amount!

In early June 2023, Hayes Hunter argued to the Court (1) that damages could easily have been calculated based on the parties’ respective obligation to transferred money or property into escrow, and (2) that even if the Court thought damages were too difficult to calculate, then $730,000 was in no way a “reasonable forecast” of what the opposing side’s actual damages would be on late transfers.

The Court agreed with attorneys from Hayes Hunter, struck the penalty clause from the settlement agreement, and replaced it with a more reasonable 10% annual simple interest rate on late transfers. The difference between the new interest rate and the unpaid penalty fees was more than $250,000 in damages the client would no longer have to pay. 

The second time walking away from the courthouse the client most certainly did so feeling very happy.

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Charles Hunter