Lunch & Learn Liquidated Damages Best Practice Alistair Maughan 10 February 2014 Morrison & Foerster (UK) LLP

Lunch & Learn 2 nd Monday of each month 45 minutes via webinar Unaccredited CPD points Rolling 3 month schedule Monday, 10 March: IP rights: Effect of a Company s Failure or Financial Distress Speaker: Howard Morris Monday, 14 April: Structuring Multi-country Agreements: Choosing Key Clauses Speaker: Tim Roughton Monday, 12 May: Keep it in the Family: Retaining Privilege in Sensitive Documents Speaker: Alan Owens 2

Today Questions at the end. Or e-mail me afterwards Phones are muted to reduce background noise I ll unmute at the end This is MoFo. 3

Liquidated Damages 1. What are Liquidated Damages? 2. Why choose LDs? 3. LDs and Penalty Clauses 4. Early Termination Payments 5. Take or Pay Clauses 6. Sole and Exclusive Remedy? 7. Earn-back? 8. Practical Drafting Approaches 4

What and Why? What are Liquidated Damages? Why choose LDs? Payable when there s a delay in delivery or completion of a project LDs are about time; Service Credits are about quality Typical formula may be X,000 (or X% of charges) per week of delay in hitting a specified timescale Customer Greater certainty Preserve the commercial Relationship Avoids wasted court time Focuses supplier attention Supplier Greater certainty Preserve the commercial Relationship Avoids wasted court time Downside is added layer of risk 5

LDs and Penalty clauses Hallmark of LDs clause: The parties confirm that these sums represent a genuine pre-estimate of X's loss. To avoid LDs being a penalty and therefore unenforceable whether a provision is to be treated as a penalty is a matter of construction, to be resolved by asking whether at the time the contract was entered into the predominant contractual function of the provision was to deter a party from breaking the contract or to compensate the innocent party for breach (Lordsvale Finance plc v Bank of Zambia [1996] QB 752, 762G) But genuine pre-estimate is not the only test 6

Penalties Cavendish Square Holdings v El Makdessi [2012 1st instance; 2013 Court of Appeal] If the seller breached the restrictive covenants, the agreement provided that: he would not be entitled to receive certain deferred and conditional consideration payments due to him (Clause 5.1) the defaulting seller could be required to sell the remaining shares held by that seller and the purchase price was to be calculated by reference to the net asset valuation on the date on which the seller defaulted and not the purchase price which C would otherwise have to pay to the seller if it exercised its option to acquire the remaining shares in the company had the seller not been in default (Clause 5.6) Makdessi argued that these provisions were unenforceable penalty clauses 7

High Court Clause 5.1 was not a penalty: Penalties it was commercially justified because it sought to adjust the purchase price in respect of the first 47.4% of shares purchased by C it had been the subject of detailed negotiation by experienced solicitors and, as a result, the risk of oppression was reduced it was not an extravagant consequence of the default Clause 5.6 was not a penalty: its commercial purpose was to de-couple the parties in the event of breach and adjust the purchase price in respect of the remaining 20% of the shares held by M the purpose of the clause was not to deter and M had not shown that it was oppressive it was fully negotiated by experienced solicitors and there was a level playing field 8

Penalties Court of Appeal High Court decision overturned Starting point = genuine pre-estimate of loss On the facts, these clauses were extravagant and unreasonable and so not a genuine pre-estimate of loss Could the clauses be rescued because of a commercial justification? 9

Penalties Lessons Clauses that require the payment of an amount on the occurrence of specified breaches are not the only clauses that can amount to unenforceable penalties Try to set LDs within a reasonable range Also consider the commercial justification for the clause and record it 10

Early Termination Payments Henning Berg v Blackburn Rovers F.C. Blackburn Rovers terminated Berg s employment and were alleged to be liable to pay 2.25 million as required by Berg s services agreement as a result of terminating the services agreement pursuant to the following clause: In the event that the Club shall at any time wish to terminate this Agreement with immediate effect it shall be entitled to do so upon written notice to the Manager and provided that it shall pay to the Manager a compensation payment by way of liquidated damages in a sum equal to the Manager s gross basic salary for the unexpired balance of the Fixed Period assuming an annual salary of 900,000 Blackburn Rovers then alleged that the clause was a penalty clause and unenforceable 11

Early Termination Payments Held The clause was not a penalty: the contract allowed termination by Blackburn Rovers on notice and the exercise by Blackburn Rovers of its rights under the clause obliged it to pay a sum of money to Berg a sum of money payable under a contract on the occurrence of an event other than for breach of contractual duty is not a penalty But the open goal was to describe this as liquidated damages in the first place 12

Take or Pay Clauses E-Nik Ltd v. Dept. for Communities and Local Government The consultancy services agreement said: 2.1 The Authority hereby undertakes to purchase minimum of 500 days of Consultancy from the Supplier per year based on project requirement, additional days will be required once the purchased days have been exhausted. 2.3 The Authority shall pay the Supplier fees at the rate of not less than 850 per day but subject to mutually agreed assignment notes for each change request. This rate may be revised upward at the time of issue of an Assignment Note to reflect the complexity of the Services requisitioned or the level of skill required for the provision of the Services. 13

Take or Pay Clauses E-Nik argued that clause 2.1 required DCLG to purchase a minimum of 500 days of consultancy services each year, and that clause 2.3 required DCLG to pay E-Nik at a rate of 850 per day for making the services available to DCLG. So, E-Nik claimed for the unpaid balance of the 500 days per year DCLG argued that, if E-Nik s arguments regarding clauses 2.1 and 2.3 were correct, the clauses amounted to an unenforceable penalty clause because DCLG would be compelled to pay for the minimum amount of services throughout the contract, whether or not supplied 14

Held: Take or Pay Clauses E-Nik s construction of clauses 2.1 and 2.3 was correct The monies owed to E-Nik by DCLG amounted to a debt rather than a damages payment Clauses 2.1 and 2.3 and the obligation to pay for minimum quantities of the services, even if not ordered, did not amount to a penalty clause: they were commercially justifiable because E-Nik was obliged to keep available the resources required to provide the consultancy services at rates at or below the rates regularly charged by E-Nik to DCLG under previous agreements 15

Take or Pay Clauses Lessons Remember that a take or pay clause can qualify as a penalty Ensure that take or pay clause makes clear that: the minimum commitment is unqualified and unconditional payment under the clause is not dependent upon specific orders or requests from the customer any monies due from the customer under the clause are debts and not claims for damages 16

Other Issues Sole and Exclusive Remedy? Earn-back? Maybe yes, during the initial specified period Probably not, except if you go for LDs at interim stages This is MoFo. 17

Practical Drafting Approaches 1. Focus on the ultimate end date. Don t worry about imposing LDs on intermediate milestones (unless they are really important) 2. Don t specify sums on breach which are so high that they couldn t possibly be commercially justifiable or a genuine pre-estimate of loss 3. Keep calculations 4. Different types of breach should attract different sums in LDs 5. Include the genuine pre-estimate of loss or commercial justification wording 18

Practical Drafting Approaches What level of LDs is acceptable? Elements of the perfect clause What s the maximum acceptable delay? What s the maximum at risk amount? Avoid one size fits all Do LDs accrue per day, week, month (or part thereof) of delay? Set the LDs accrual rate should accrue to a maximum threshold level Think about the relationship between X and Y - time and money to come up with the LD accrual rate Consider sole and exclusive remedy Consider earn-back Consider what happens after the maximum period of delay 19

Lunch & Learn Alistair Maughan Partner, Technology Transactions T: (+44) 20 7920 4066 E: amaughan@mofo.com Monday, 10 March: IP rights: Effect of a Company s Failure or Financial Distress Speaker: Howard Morris Monday, 14 April: Structuring Multi-country Agreements: Choosing Key Clauses Speaker: Tim Roughton Monday, 12 May: Keep it in the Family: Retaining Privilege in Sensitive Documents Speaker: Alan Owens 20