Liquidated damages option clause nixed

An option clause in a real estate contract allowing the seller either to pursue actual damages or to seek liquidated damages cannot stand, a Fairfax Circuit judge has ruled in a case of first impression.

The option undercuts the purpose of liquidated damages in a contract and it serves as a penalty on the buyer, which is untenable, the judge said.

The case is Sagatov Builders LLC v. Christian Hunt (VLW 014-8-073), with the ruling from Fairfax Circuit Judge Charles J. Maxfield.

The builder and the buyer entered into a real estate contract to improve property in Willow Creek Estates in Fairfax County. The buyer was to pay a $50,000 deposit.

The agreement included a clause with an option: If the buyer was in default, the seller would have all legal and equitable remedies, or it could terminate the contract and declare the deposit forfeited as liquidated damages.

The seller filed suit claiming default and electing to take liquidated damages; the buyer responded that the option clause is a penalty as a matter of law and that the seller should be forced to seek actual damages for any breach.

Maxfield noted that Virginia had not yet ruled on this legal issue.

He looked to the underlying purpose of liquidated damages – “providing agreed compensation for loss or injury when actual damages may be uncertain and difficult to prove.”

Citing a 1888 case from the Supreme Court of Virginia, he added that liquidated damages clauses are supposed “to avoid all future questions of damage which may result from a violation of the contract.”

The option clause in the Sagatov Builders case “fails to achieve that fundamental purpose,” Maxfield wrote.

And the option functions as a penalty, which is unlawful.

Drawing on Williston on Contracts, Maxfield said that the option works where the liquidate amount of the deposit exceeded the actual damages incurred, “establishing the implication that the parties intended to punish the defaulting party.”

The judge sustained a demurrer to the breach of contract claim, with leave to amend the complaint to seek actual damages.

Updated July 25 to correct Maxfield name in one instance.