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.
Atrium appealed.
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
P:
972.716.1888
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