Atrium Medical Center owns and operates a 60-bed acute care hospital in Stafford Texas. In November 2012 Atrium entered into a five-year service contract with ImageFirst Healthcare Laundry for laundry services. In exchange, ImageFirst agreed to furnish clean, health-care quality linens.
Atrium and ImageFirst anticipated that the invoices for these services would vary, depending on Atrium’s weekly linen needs. It seems that Atrium had just started business operations, and did not know how long linens would last or how often they would need to be laundered. So both parties wanted flexibility regarding pricing based on linen replacement, and cleaning retrieval / delivery needs.
Possibly as a result of the alleged embezzlement of a former manager, Atrium experienced financial distress soon after the contract was signed. As a consequence, Atrium canceled the contract in September 2013 and found another vendor.
Early contract termination triggered the liquidated damages clause in the ImageFirst contract.
There were four years remaining on the contract when Atrium canceled. So ImageFirst sought both collection of unpaid invoices and interest of $237,512, and compensation for its future profits equal to $716,330. ImageFirst arrived at that number because the liquidated damages provision required payment of a cancellation charge of 40% of the then-current invoice amount, multiplied by the number of weeks remaining in the term.
At the time of cancellation ImageFirst was billing Atrium over $8k per week.
Payment demands were not successful, so ImageFirst asserted a lawsuit in November 2013. The trial court ruled in March 2016 that the liquidated damages clause was not a penalty and that ImageFirst was entitled to its contractual profit of $716,330 plus unpaid invoices of $237,512, and other amounts related to interest and attorney’s fees. The total amount was over $1.4 million.
The court of appeals affirmed the trial court’s decision in December 2017, finding that at the time of contracting actual damages were very difficult, if not impossible, to determine. Atrium was unclear of its future needs and neither party could predict how long linens would last. And as a consequence, a 40% cancellation charge was not a penalty but rather a reasonable forecast of the harm likely caused to ImageFirst, supported by the facts of this case and ImageFirst’s normal profit margins.
Atrium appealed again.
The Supreme Court started by indicating a disposition to uphold contractual provisions, tempered by a “universal rule” that damages for breach of contract are limited to fair compensation for the loss actually sustained. Damages provisions that are compensatory will be upheld. Damages clauses that violate this rule function as a penalty and are unenforceable, as are provisions that bear no rational relationship to actual damages.
The test is applied only when damages can be quantified, much like looking in the rear-view mirror for assistance in moving forward. At that moment damages are incurred, the injured party assesses its position and then compares that number to the liquidated damages language.
A significant difference between what was anticipated and what actually occurred, measured when damages are suffered, may void a liquidated damages clause as the parties must agree to a “reasonable forecast of just compensation.” Conversely, a realistic forecast of future damages can be upheld, once damages are known and tested against the formula.
The high Court upheld ImageFirst’s liquidated damages provision since it contained a rational formula for future economic pain, that could be not be exactly computed when the contract was signed. ImageFirst wins, again. See Atrium Medical Center, LP vs. Houston Red C LLC dba ImageFIRST Healthcare Laundry Specialists; Case No. 18-0228; Supreme Court of Texas; February 7, 2020: https://law.justia.com/cases/texas/supreme-court/2020/18-0228.html.
Lessons Learned / Questions Asked:
1. Lesson: Forecasting damages when a contract is signed is inherently a difficult proposition. It may help to state that the parties are doing the best they can to anticipate and provide for a future situation that may never occur, and believe that the chosen formula will provide a reasonable forecast of just compensation and profit.
2. Lesson: If your provision is tested in a Court, know that expert testimony will be used to both support and defeat the provision. Meaning, if your normal profits are 15% of sales or services, then using a liquidated damages provision containing a 35% formula has little chance of succeeding and instead could easily backfire and render the entire provision unenforceable.
3. Question: Does your contract contain a liquidated damages provision? Perhaps you are safer if it does not, and if required to do so by unfortunate circumstances you can prove your damages in court. One can but wonder if that is a safer alternative to using a formula that, when drafted and used at the inception of the contract, looks to be reasonable, but when tested many years later looks patently out of touch with reality.
Stuart A. Lautin, Esq.*
* Board Certified, Commercial (1989) and Residential (1988) Real Estate Law,
Texas Board of Legal Specialization
Licensed in the States of Texas and New York
Higier Allen & Lautin, PC
2711 N. Haskell Avenue, Suite 2400
Dallas Texas 75204