BROKER AWARDED LIQUIDATED DAMAGES DESPITE 'TREMENDOUS WINDFALL'

August 30, 2004

Steven P. Garmisa
Hoey & Farina Attorney
garmisa@hoeyfarina.com
1-888-425-1212

When a contract that provides for payment of a series of commissions contains a liquidated damages provision calling for payment of all the commissions, is this remedy reasonable and enforceable?

Yes, the Illinois Appellate Court concluded in a case against a sophisticated condominium developer, answering a question of first impression in Illinois. It did not matter that, under the circumstances of the case, the real estate broker allegedly wound up getting a "windfall." Jameson Realty Group v. Kostiner, 2004 WL 1698875 (1st Dist., July 29).

Jameson Realty Group filed a complaint alleging that it was hired by Lewis Kostiner to sell condominium units in a building at 850 W. Adams St. in Chicago. An exclusive listing agreement, lasting one year, provided for payment of 5 percent commission to Jameson whenever it provided a buyer who was "ready, willing and able" to purchase a unit.

The liquidated damages provision stated, "If broker's authority to sell is revoked or said property is withdrawn from the market during the period of broker's authority to sell hereunder, seller shall pay broker upon such revocation or withdrawal, not as a penalty, but as liquidated damages, an amount equal to the commission payable on the full price listed above."

A schedule attached to the contract provided a price for each unit.
Nearly half a year into the contract, only four units had been sold. With 13 units still unsold, Kostiner allegedly terminated the contract with Jameson.

Filing a complaint in Cook County Circuit Court, Jameson sought payment under the liquidated damages provision.

Ruling for Jameson, the Circuit Court ordered Kostiner to pay $261,820. On appeal, Kostiner argued among other things that the liquidated damages provision was unenforceable. The Appellate Court disagreed.

Here are some highlights of Justice Patrick J. Quinn's opinion (with various omissions not noted in the quoted text):

"Kostiner contends that the liquidated damages provision in the agreement was merely a penalty provision and therefore unenforceable. Specifically, he argues (1) the parties never discussed this provision before signing the agreement, (2) there was 'no specified amount contained in the purported liquidated damages clause,' and (3) '[t]he percentage amount referenced [in the liquidated damages clause] did not bear any relationship to the damages that might be sustained.'

"It is a general rule of contract law that, for reasons of public policy, a liquidated damages clause which operates as a penalty for non-performance or as a threat to secure performance will not be enforced.

"Although the public policy behind this rule has never been explained clearly, under Illinois law, a liquidated damages provision will be enforced if it satisfies the test outlined in section 356 of the Restatement (Second) of Contracts: 'Damages for breach by either party may be liquidated in the agreement but only at an amount that is reasonable in the light of the anticipated or actual loss caused by the breach and the difficulties of proof of loss. A term fixing unreasonably large liquidated damages is unenforceable on grounds of public policy as a penalty.'

"From the Restatement, our courts have parsed three elements that must be met in order to validate such a clause: (1) the parties intended to agree in advance to the settlement of damages that might arise from the breach; (2) the amount of liquidated damages was reasonable at the time of contracting, bearing some relation to the damages which might be sustained; and (3) actual damages would be uncertain in amount and difficult to prove.

"There is no fixed rule applicable to all liquidated damages agreements, and each one must be evaluated on its own facts and circumstances. When determining whether actual damages would be uncertain in amount and difficult to prove, however, courts must look to 'the time of contracting, not the time of breach.' Restatement (Second) of Contracts, section 356, comment b (1979). Additionally, the damages contained in a liquidated damages clause must be for a specific amount for a specific breach; the provision may not merely serve as a threat to secure performance or as a means to punish non-performance.

"Although exculpatory language in the contract stating that the liquidated damages provision is not a penalty does not control, it should be given some weight.

"The validity of a liquidated damages provision is a question of law and therefore is reviewed de novo.

"Numerous cases exist in which the validity of such provisions are determined in the context of a 'real estate sales contract,' i.e ., where either a buyer or seller of land sought liquidated damages because the other backed out of an impending real estate transaction; however, no case in Illinois has been cited or found in which such a provision was construed in the 'real estate brokerage contract' context, i.e., where a broker sought to recover liquidated damages from a seller who prematurely terminated an exclusive listing agreement.

"In the real estate sales contract context, where the requisite three elements are met, courts will generally enforce the liquidated damages provision. The issue here is whether such a provision should be treated differently simply because it is found in a real estate brokerage contract.

"Although the two contracts are different in nature, the former being a contract for the sale of real property and the latter being a contract for the services of a broker in connection with the sale of real property, there is no reason to treat a liquidated damages provision in a real estate brokerage contract differently.
"The foregoing view is in accord with courts from other jurisdictions that have considered the validity of a liquidated damages clause in a real estate brokerage contract.

"The [out-of-state] cases demonstrate two propositions: First, there is no reason to treat a liquidated damages clause in a real estate brokerage contract any differently than one found in any other contract. The uncertainty of actual damages at the time of contract, a fact that must be true for a liquidated damages clause to be valid and enforceable, is inherent in a real estate brokerage contract context.

"As the Arizona Court of Appeals stated in [Larson-Hegstrom v. Jeffries, 701 P.2d 587 (Az. App. 1985)]: 'Compensation associated with real estate contracts is by its nature difficult to estimate since what is being compensated is the presentation of a ready, willing and able buyer, regardless of any real effort or expenditures on the part of the agent. When the seller unilaterally withdraws the property from the hands of its agent and conveys it himself, he has deprived the agent of his opportunity to present the requisite buyer under the terms of the agency.' 701 P.2d at 592.

"Further, one of the benefits that a liquidated damages clause provides to contracting parties and courts alike is that: 'When damages for breach of contract would be difficult for a court to determine after the breach occurs, it makes sense for the parties to specify in the contract itself what the damages for breach shall be; this reduces uncertainty and litigation costs and economizes on judicial resources as well.' XCO International Inc. v. Pacific Scientific, 369 F.3d 998, 1001 (7th Cir. 2004).

"Thus, the real estate brokerage contract context offers an ideal setting for such a clause.

"Second, those clauses that base the amount of liquidated damages upon the broker's bargained-for commission, as opposed to some estimate of damages made from whole cloth, will be upheld as a reasonable estimate of damages. Therefore, applying liquidated damages clause principles under Illinois law, as well as cases from other jurisdictions construing such clauses in the real estate brokerage contract context, the liquidated damages clause in this case was valid for the following reasons.

"First, the liquidated damages provision was clear and unambiguous on its face, which demonstrates that the parties intended to agree in advance to the settlement of damages that might arise from the breach. Where the terms of an agreement are unambiguous, the parties' intent must be determined solely from the language of the agreement itself, and it is presumed that the parties inserted each provision deliberately and for purpose.

"During negotiations with Jameson, Kostiner struck and added provisions in the agreement (a form contract), including a provision that reduced Jameson's commission to 2 percent if the buyer was a tenant of 'Annie Properties.' As an experienced developer of residential real estate, Kostiner cannot reasonably argue that he was not aware either of the presence or import of this provision.
"Second, the amount of damages was specified in the agreement.

Kostiner's argument to the contrary notwithstanding, it is clear that the amount of liquidated damages was to equal 5 percent of the original asking price for each unit that had not been sold at the time of breach. An attached list contained the original asking price for each unit, a list that was explicitly referenced in the agreement and signed and dated by Kostiner himself.

"Third, at the time the agreement was signed, the amount of damages to be paid under the liquidated damages provision bore a reasonable relationship to the damage Jameson might suffer if Kostiner wrongfully terminated the agreement.

"Under the terms of the agreement, Jameson was to receive a commission of 5 percent of the purchase price for each unit sold. If Kostiner terminated the agreement, Jameson would lose any chance at obtaining that commission; Kostiner would have deprived Jameson of its opportunity to present the requisite buyer under the terms of the agreement. Therefore, the liquidated damage clause simply provided Jameson, which the Circuit Court found had used its best efforts in marketing the units for Kostiner, with an amount equal to what it would have received had it been afforded the opportunity to sell the units.

"Kostiner contends that Jameson received a 'tremendous windfall' through the Circuit Court's award of liquidated damages because it obtained 'the maximum profit it could have obtained if it had sold all the units, plus the time value of its services.' Kostiner argues that Jameson most likely would have been required to split any commission with the buyer's broker, unless it also represented the buyer in the sale of the unit and that, by awarding commissions on all the unsold units at the time of termination, the clause assumed that Jameson would have sold all of the units during the exclusive listing period provided under the agreement.

"Kostiner's arguments, however, prove the validity of the clause; they show just how uncertain and difficult calculating actual damages was at the time of contracting. Therefore, the liquidated damages clause here was valid and enforceable."

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