(This syllabus is not part of the opinion of the Court. It has been prepared by the Office of the Clerk for
the convenience of the reader. It has been neither reviewed nor approved by the Supreme Court. Please
note that, in the interests of brevity, portions of any opinion may not have been summarized).
Argued January 31, 1994 -- Decided August 2, 1994
POLLOCK, J., writing for a unanimous Court.
Wasserman's Inc. (Wasserman's) had been leasing certain property owned by the Township of
Middletown (Township) from 1948 through 1968. In 1969, the Township advertised for public bids to lease
the property, and Wasserman's submitted the sole bid. Subsequent negotiations resulted in the Township
adopting a resolution approving the commercial lease on September 22, 1970, which the parties signed on
May 21, 1971. The agreement contained a cancellation clause that provided that the Township would pay the
lessee, Wasserman's, a pro-rata reimbursement for any improvement costs and damages of twenty-five
percent of the lessee's average gross receipts for one year if it cancelled the lease.
In 1971, Wasserman's made the agreed on improvements, spending $142,336.01, In August 1973,
Wasserman's sold its business and sublet the premises to Rocco Laurino doing business as Jo-Ro, Inc. (Jo-Ro). The Township cancelled the lease effective December 31, 1988. In June 1989, the Township sold the
property at public auction for $610,000, almost thirteen times the value of the property at the time the
Township had leased the premises to Wasserman's in 1971.
The statute in effect when Wasserman's and the Township executed the lease, N.J.S.A. 40:60-42
(section 42), provided that the public entity could lease municipal property to a private person who paid the
highest rent. On July 1, 1971, six weeks after the Township and Wasserman's signed the lease, N.J.S.A.
40A:12-14 (section 14) took effect, replacing section 42 and requiring public bidding for leases of unused
municipal property.
Wasserman's and Jo-Ro sued for breach of contract, seeking damages pursuant to the terms of the
lease. The Township argued that section 14 should apply retroactively to void the lease. In the alternative,
the Township sought a declaration of invalidity of that part of the cancellation clause that required the
Township to pay damages equal to twenty-five percent of the lessee's gross receipts.
The trial court granted partial summary judgment in favor of Wasserman's and Jo-Ro, finding
the lease and the cancellation clause enforceable. On a subsequent motion, the court awarded Wasserman's
and Jo-Ro damages of $346,058.44 plus ten-percent prejudgment interest. To reach that figure, the court
calculated the improvements compensation to be $55,748.27 and the gross receipts compensation to be
$290,310.18.
On appeal, the Appellate Division affirmed substantially for the reasons stated by the Law Division.
The Supreme Court granted certification.
HELD: The lease between Wasserman's and the Township of Middletown was enforceable; therefore, the
Township is liable and Wasserman's and Jo-Ro for terminating the lease. The agreement did not
violate N.J.S.A. 40:60-42, and N.J.S.A. 40A:12-14 does not apply retroactively to the lease.
1. The Township, when negotiating the lease, satisfied the requirements of the then-controlling statute, section 42. Public bidding is not impaired when a municipality subsequently bargains for a needed change in
a contract and makes the best deal it can for the entity. Because there is no evidence of bad faith,
dishonesty or corruption, the parties negotiated in good faith over the details of the lease. (pp. 6-10)
2. Nothing in the statutory language or history suggests that the Legislature intended that section 14 be
applied retroactively. The lease was validly executed in accordance with section 42 and section 14 will not be
applied retroactively. (pp. 11-12)
3. The validity of a stipulated damage clause depends on whether a court interprets the clause as an
unenforceable penalty or as an enforceable provision for liquidated damages. A stipulated damage clause
must constitute a reasonable forecast of the provable injury resulting from a breach, otherwise the clause will
be unenforceable as a penalty and the non-breaching party will be limited to conventional damages.
Enforceability is to be determined at the time of contract or when the contract is breached. Because
stipulated damage clauses are presumptively reasonable, the burden of proof is on the party challenging the
stipulated damages clause. (pp. 12-21)
4. A cancellation clause is unreasonable if it does more than compensate the aggrieved party for their
approximate actual damages caused by the breach. Damages based on gross receipts run the risk of being
found unreasonable. Gross receipts do not generally reflect actual losses incurred because they are
speculative and may award the non-breaching party a windfall. In this case, it cannot be determined whether
the stipulated amount was based on damages that would likely flow from a breach or whether it was on
arbitrary figure unrelated to any such damages. Moreover, it cannot be determined from Jo-Ro's gross
receipts the losses sustained because of the cancellation; the twenty-five percent figure found by the trial
court does not necessarily reflect Jo-Ro's actual losses when considering operating expenses or relocation
costs and other expenses attributable to the Township's breach. Thus, the matter is remanded to the trial
court to determine whether the clause requiring stipulated damages based on the lessee's gross receipts is a
valid liquidated damages clause. (pp. 21-28)
The judgment of the Appellate Division is AFFIRMED IN PART, REVERSED IN PART and the
matter is REMANDED to the Law Division.
CHIEF JUSTICE WILENTZ and JUSTICES CLIFFORD, HANDLER, O'HERN, GARIBALDI, and
STEIN join in JUSTICE POLLOCK's opinion.
SUPREME COURT OF NEW JERSEY
A-
70 September Term 1993
WASSERMAN'S INC. and JO-RO, INC.,
Plaintiffs-Respondents,
v.
TOWNSHIP OF MIDDLETOWN,
Defendant-Appellant.
Argued January 31, 1994 -- Decided August 2, 1994
On certification to Superior Court, Appellate
Division.
William F. Dowd argued the cause for
appellant (Dowd & Reilly, attorneys; Mr. Dowd
and Bernard M. Reilly, on the brief).
Roy D. Curnow argued the cause for
respondents (Drazin and Warshaw, attorneys).
The opinion of the Court was delivered by
POLLOCK, J.
Pursuant to a public advertisement for bids, plaintiff
Wasserman's Inc. (Wasserman's) and defendant, Township of
Middletown (the Township or Middletown), entered into a
commercial lease for a tract of municipally-owned property. The
agreement contained a clause providing that if the Township
cancelled the lease, it would pay the lessee, Wasserman's, a
pro-rata reimbursement for any improvement costs and damages of
twenty-five percent of the lessee's average gross receipts for
one year. In 1989, the Township cancelled the lease and sold the
property, but refused to pay the agreed damages. On cross-motions for summary judgment, the Law Division held that the
lease and the cancellation clause were enforceable. It
subsequently required the Township to pay damages in the amount
of $346,058.44 plus interest. In an unreported opinion, the
Appellate Division affirmed. We granted certification,
134 N.J. 478 (1993), and now affirm the judgment on liability but reverse
and remand for a plenary trial on damages. We conclude that the
lease is enforceable. We affirm the award of renovation costs
and remand to the Law Division the issue of the enforceability of
the stipulated damages clause.
The Township owned a parcel of approximately 20,500 square feet in a commercial area at 89 Leonardville Road, in the Belford section of the Township. From 1948 to 1968, Wasserman's leased the property from the Township for a 3,200-square-foot general store. In 1969, the Township advertised for bids to lease the property, which the Township evaluated at $47,500. Wasserman's submitted the sole bid. After rejecting Wasserman's bid, the Township again advertised in May 1970. Once again, Wasserman's submitted the only bid. Subsequent negotiations resulted in the Township adopting a resolution approving the lease on September 22, 1970. The parties signed the lease on May 21, 1971.
At the center of the dispute is the cancellation clause in
the lease. The bid specifications provided that if the Township
cancelled the lease, it would pay the tenant a pro-rata
reimbursement of improvement costs. Consistent with the
specifications, the clause provides in part for reimbursement:
"payment to be made shall be (1.) total value of all improvements
made by lessee at time of construction x (multiplied by) years
remaining in Lease term . (divided by) total number of years in
Lease term." More controversial is the second half of the
clause, the terms of which were not included in the original
specifications. That provision requires the Township to pay
"(2.) twenty-five percent of the lessee[']s average gross
receipts for one year (to be computed by + (adding) the
lessee[']s total gross receipts for the lessee[']s three full
fiscal years immediately preceding the time of cancellation of
the lease and . (dividing by) 12 (twelve)[)]." The lease also
provided for a fixed monthly rental of $458.33, with no
escalation for the entire thirty-year term.
Wasserman's made the agreed improvements, spending $142,336.01 in 1971 on the expansion and renovation of the store, which now is approximately 5,600 square feet. In August 1973, Wasserman's sold "the business," presumably the corporate assets, and sublet the premises to Rocco Laurino doing business as Jo-Ro, Inc. (Jo-Ro). The sublease provided that Jo-Ro was to pay Wasserman's a monthly rent of $1,850. Wasserman's and Jo-Ro,
jointly described as "plaintiffs," provided for an allocation of
any payments made by the Township if it cancelled the lease.
In 1977, Samuel Krawet and Arnold Kornblum purchased from
Laurino all of the Jo-Ro stock for $95,000. In connection with
the sale, Laurino executed an affidavit, representing that the
lease between Middletown and Wasserman's was in full force and
effect. Additionally, the Township sent a letter to Wasserman's
stating that the Township would permit subletting the property to
Jo-Ro.
By letter dated December 7, 1987, the Township cancelled the
lease effective December 31, 1988. Krawet and Kornblum vacated
the premises, leaving them without a place for their business.
In June 1989, the Township, after advertising the property at
public auction, sold it for $610,000, nearly thirteen times the
value of the property at the time the Township had leased it to
Wasserman's in 1971.
The statute in effect when Wasserman's and the Township
executed the lease provided:
Every municipality may lease for fixed and limited terms to any person any land or building of the municipality not presently needed for public use. If any portion of a building owned by a municipality is not presently needed for the use of the municipality, the governing body may rent such portion for private purposes to the person who will pay the highest rent
therefor, for any use not detrimental to such
building or the use of the remainder by the
municipality.
[N.J.S.A. 40:60-42, repealed by L. 1971, c.
199, § 29 (effective July 1, 1971).]
On July 1, 1971, six weeks after the Township and Wasserman's
signed the lease, N.J.S.A. 40A:12-14 took effect. The new
statute replaced N.J.S.A. 40:60-42 and requires public bidding
for leases of unused municipal property. N.J.S.A. 40A:12-14(a)
provides:
In the case of a lease to a private person . . ., said lease shall be made to the highest bidder by open public bidding at auction or by submission of sealed bids. Advertisement of the method of bidding shall be published in a newspaper circulating in the municipality or municipalities in which the leasehold is situated by two insertions at least once a week during two consecutive weeks; the lease publication to be not earlier than seven days prior to the letting of the lease. The governing body may, by resolution, fix a minimum rental with the reservation of the right to reject all bids where the highest bid is not accepted. Notice of such reservation shall be included in the advertisement of the letting of the lease and public notice thereof shall be given of the time of the letting of the lease. Such resolution may provide that upon the completion of the bidding, the highest bid may be accepted or all of the bids may be rejected. It shall also set out the conditions, restrictions and limitations upon the tenancy subject to the lease. Acceptance or rejection of the bid or bids shall be made not later than at the second regular meeting of the governing body following the completion of the bidding, and, if the governing body shall not so accept such highest bid, or reject all bids, said bids
shall be deemed to have been rejected. Any
such award may be adjourned at the time
advertised for not more than one week without
readvertising.
Contrary to N.J.S.A. 40:60-42, N.J.S.A. 40A:12-14(a) requires
public bidding if a municipality proposes to lease property to a
private person and requires that the lease "shall be made to the
highest bidder . . .." The Township argues that N.J.S.A.
40A:12-14(a) should apply retroactively to void the lease. We
disagree.
Plaintiffs sued for breach of contract, seeking in part damages under the terms of the lease. The Township filed an answer and counterclaim seeking a declaration of invalidity of that part of the cancellation clause that required the Township to pay as damages twenty-five percent of the lessee's gross receipts. Originally the Township also disputed its obligation to reimburse Wasserman's for a pro-rata portion of the cost of renovations, but it now concedes the validity of that provision.
The parties filed cross-motions for summary judgment.
The Law Division initially granted plaintiffs a partial summary judgment according "full force and effect" to the lease and the cancellation clause. On a subsequent motion, the court awarded plaintiffs damages of $346,058.44 plus ten-percent
prejudgment interest. The trial court calculated damages as
follows:
$142,336.01 (construction costs) multiplied
by 11.75 (remaining years) divided by 30
years (term of lease) for a total of
$55,748.27.
$3,483,722.25 (Jo-Ro's gross receipts for the
years 1985, 1986, 1987) divided by 12
equalling $290,310.18.
Construction compensation $ 55,748.27
Gross receipts compensation + 290,310.18
Total amount due $346,058.45
The Appellate Division affirmed substantially for the
reasons stated by the Law Division. We affirm the judgment on
liability. We find that the lease does not violate N.J.S.A.
40:60-42, which was in effect at the time of the agreement, and
that N.J.S.A. 40A:12-14 does not apply retroactively.
The Township first argues that the lease violates the requirements for a valid public contract. It points to the absence from the bid specifications of any reference to a cancellation clause providing for compensation based on gross receipts. Further, it argues that the former Township officials acted without any authority in subsequently agreeing to such a clause. We reject both arguments. When the parties negotiated
the terms of the lease in 1970 and 1971, the governing statute,
N.J.S.A. 40:60-42, did not require public bidding for a lease to
a private party. Robbins v. City of Jersey City,
23 N.J. 229,
236 (1957); Asbury Park Press, Inc. v. City of Asbury Park,
19 N.J. 182, 192 (1955). It required only that the "person pay the
highest rent therefor." Here, Wasserman's not only paid that
rent, but the Township received no other offers.
We find, as did both the Law Division and the Appellate
Division, that the Township, when negotiating the lease,
satisfied the requirements of the then-controlling statute.
Although the Township advertised for public bids, the
advertisement did not prevent it from disregarding the bids and
making the best deal that it could for the Township. Schwartz &
Nagle Tires, Inc. v. Board of Chosen Freeholders,
6 N.J. Super. 79, 81 (App. Div. 1949), certif. denied,
4 N.J. 127 (1950). A
municipality that advertises for public bids is not obligated to
accept the low bid if the bidding statutes do not apply. See
A.C. Schultes & Sons v. Township of Haddon,
8 N.J. 103, 108
(1951) (holding that "[e]ven though the municipality actually
advertised . . ., if the [bidding] statutes are inapplicable,
there is no obligation upon the city to award the contract to the
low bidder"). Unless the public bidding statutes apply, their
requirements do not control the award of bids. Peter's Garage,
Inc. v. City of Burlington,
121 N.J.L. 523, 528 (Sup. Ct.),
aff'd,
123 N.J.L. 227 (E. & A. 1939).
When the Township first advertised in 1969, only
Wasserman's, the tenant in possession, submitted a bid. In 1970,
Wasserman's again was the sole bidder. The record reveals that
when settling the final terms of the lease, the parties in good
faith negotiated the Township's right to terminate the lease.
Public bidding is not impaired when a municipality subsequently
bargains for a needed change in a contract. Greenberg v.
Fornicola,
37 N.J. 1, 10 (1962). At no time has the Township
ever submitted a shred of evidence of bad faith on anyone's part
in those negotiations. Nor does any evidence suggest that a
potential bidder would have found the property more attractive if
it had known of the modifications to the lease. Not until 1989,
after it had sold the property at a substantial gain, did the
Township question the lease's terms.
We need not go so far as the Law Division, which found the
Township's position "bizarre." For our purposes, it suffices
that the lease amendments were not detrimental to the Township's
interests, Skakel v. Township of North Bergen,
37 N.J. 369, 380
(1962), and that the executed lease was substantially similar to
the lease as described in the bid specifications. See Kotter v.
Township of East Brunswick,
160 N.J. Super. 462, 469 (App. Div.
1978) (finding under Local Public Contracts Law, N.J.S.A. 40A:11-1 to -49, that "[t]here must be a reasonable similarity between
that which is solicited and the terms of the contract entered
into").
Even when public-bidding statutes apply, they do not
foreclose changes "when the public body in its own interest seeks
an amendment to meet an unanticipated development in
circumstances in which new bidding would be inappropriate or
impractical." Greenberg, supra, 37 N.J. at 10. Here, new
bidding would have been "inappropriate" and "impractical." After
two invitations to bid, the Township attracted only the tenant in
possession, Wasserman's.
The purpose of competitive bidding is to obtain the best
economic result for the public entity and ultimately for the
taxpayer. See id. at 6. Any modification must "not be
detrimental to the interests of the municipality and must not
make the proposal more attractive to any potential bidders."
Skakel, supra, 37 N.J. at 380. Nothing in the record indicates
that a third attempt would have attracted other bidders. The
absence of a provision to escalate rent and the inclusion of one
to compensate the tenant if the Township sold the property do not
necessarily render the lease "detrimental to the interests of the
municipality." Ibid. To the contrary, the record suggests that
Wasserman's would not have signed the lease if the Township had
not made those concessions. In the absence of any evidence of
bad faith, dishonesty, or corruption, we conclude that the
parties negotiated in good faith over the details of the lease.
We also reject the Township's argument that N.J.S.A. 40A:12-14, which took effect six weeks after the signing of the lease, determines the lease's validity. Nothing in the statutory language or history suggests that the Legislature intended that the statute should be applied retroactively. As salutary as the provisions of N.J.S.A. 40A:12-14 may be in requiring public bidding for the lease of municipal property, the Township has made no showing that those provisions should apply to leases executed before the effective date of the statute. Therefore, N.J.S.A. 40:60-42, which was still in effect at the time of the execution of the lease, governed the validity of the formation of the lease. See Board of Educ. v. Employees Ass'n, 178 N.J. Super. 477, 480 (App. Div. 1981) (stating that validity of contract is determined by law in effect at time of contracting and that subsequent change in law cannot make agreement illegal, if legal when made). Finally, the retroactive application of N.J.S.A. 40A:12-14 to invalidate the lease nineteen years after its execution, with eleven years yet to run, would create the risk of contravening the contract clauses of article 1, section 10 of the federal constitution and article IV, section 7, paragraph 3 of the New Jersey Constitution.
The lease was validly executed in accordance with N.J.S.A. 40:60-42, the statute in effect at the time of execution. We decline to apply N.J.S.A. 40A:12-14 retroactively. Thus, we affirm the partial summary judgment sustaining the validity of
the lease. Before us, the Township does not dispute the award of
$55,748.27 in damages to compensate Wasserman's for improving the
premises.
The provision in the termination clause providing for damages based on the lessee's gross receipts presents a more difficult issue. The issue is whether that provision is an enforceable liquidated damages provision or is an unenforceable penalty clause.
Disapproval of penalty clauses originated at early common
law when debtors bound themselves through sealed penalty bonds
for twice the amount of their actual debts. Charles J. Goetz &
Robert E. Scott, Liquidated Damages, Penalties and the Just
Compensation Principle: Some Notes on an Enforcement Model and a
Theory of Efficient Breach,
77 Colum. L. Rev., 554, 554 (1977)
(hereinafter Goetz & Scott). Because clauses in penalty bonds
"carried an unusual danger of oppression and extortion," equity
courts refused to enforce them. Id. at 555. "This equitable
rule, designed to prevent over-reaching and to give relief from
unconscionable bargains, was later adopted by courts of law."
John D. Calamari & Joseph M. Perillo, The Law of Contracts,
§ 14-31 at 639 (3d ed. 1987) (hereinafter Calamari & Perillo).
In a sense, judicial reluctance to enforce penalty clauses is a
product of history.
For more than five centuries, courts have scrutinized
contractual provisions that specify damages payable in the event
of breach. Wassenaar v. Panos,
331 N.W.2d 357, 362 (Wis. 1983);
Goetz & Scott, supra,
77 Colum. L. Rev. at 554. The validity of
these "stipulated damage clauses" has depended on a judicial
assessment of the clauses as an unenforceable penalty or as an
enforceable provision for "liquidated damage." Thus,
"'[l]iquidated damages' and 'penalties' are terms used to reflect
legal conclusions as to the enforceability or nonenforceability,
respectively, of stipulated damage clauses." Kenneth W. Clarkson
et al., Liquidated Damages v. Penalties: Sense or Nonsense?, 1
978
Wis. L. Rev. 351, 351 n.1 (hereinafter Clarkson).
Thirty years ago, the Appellate Division distinguished
liquidated damages and penalty clauses:
Liquidated damages is the sum a party to
a contract agrees to pay if he breaks some
promise, and which, having been arrived at by
a good faith effort to estimate in advance
the actual damages that will probably ensue
form the breach, is legally recoverable as
agreed damages if the breach occurs. A
penalty is the sum a party agrees to pay in
the event of a breach, but which is fixed,
not as a pre-estimate of probable actual
damages, but as a punishment, the threat of
which is designed to prevent the breach.
Parties to a contract may not fix a
penalty for its breach. The settled rule in
this State is that such a contract is
unlawful.
[Westmount Country Club v. Kameny,
82 N.J.
Super. 200, 205 (1964) (citations omitted).]
Stating the distinction, however, has been easier than
describing its underlying rationale. "'[T]he ablest judges have
declared that they felt themselves embarrassed in ascertaining
the principle on which the decisions [distinguishing penalties
from liquidated damages] were founded.'" E. Allan Farnsworth,
Contracts § 12.18 at 937 (2d ed. 1990) (alterations in original)
(quoting Cotheal v. Talmage,
9 N.Y. 551, 553 (1854)); see also
Giesecke v. Cullerton,
117 N.E. 777, ___ (Ill. 1917) (observing
that "no branch of the law is involved in more obscurity by
contradictory decisions").
As the law has evolved, a stipulated damage clause "must
constitute a reasonable forecast of the provable injury resulting
from breach; otherwise, the clause will be unenforceable as a
penalty and the non-breaching party will be limited to
conventional damage measures." Goetz & Scott, supra,
77 Colum.
L. Rev. at 554. So viewed, "reasonableness" emerges as the
standard for deciding the validity of stipulated damages clauses.
See Wassenaar, supra, 331 N.W.
2d at 361 (noting that "[t]he
overall single test of validity is whether the clause is
reasonable under the totality of circumstances").
The reasonableness test has developed as a compromise
between two competing viewpoints concerning stipulated damages
clauses. The Wisconsin Supreme Court has described the policy
considerations underlying these viewpoints:
Enforcement of stipulated damages
clauses is urged because the clauses serve
several purposes. The clauses allow the
parties to control their exposure to risk by
setting the payment for breach in advance.
They avoid the uncertainty, delay, and
expense of using the judicial process to
determine actual damages. They allow the
parties to fashion a remedy consistent with
economic efficiency in a competitive market,
and they enable the parties to correct what
the parties perceive to be inadequate
judicial remedies by agreeing upon a formula
which may include damage elements too
uncertain or remote to be recovered under
rules of damages applied by the courts. In
addition to these policies specifically
relating to stipulated damages clauses,
considerations of judicial economy and
freedom of contract favor enforcement of
stipulated damages clauses.
A competing set of policies disfavors
stipulated damages clauses, and thus courts
have not been willing to enforce stipulated
damages clauses blindly without carefully
scrutinizing them. Public law, not private
law, ordinarily defines the remedies of the
parties. Stipulated damages are an exception
to this rule. Stipulated damages allow
private parties to perform the judicial
function of providing the remedy in breach of
contract cases, namely, compensation of the
nonbreaching party, and courts must ensure
that the private remedy does not stray too
far from the legal principle of allowing
compensatory damages. Stipulated damages
substantially in excess of injury may justify
an inference of unfairness in bargaining or
an objectionable in terrorem agreement to
deter a party from breaching the contract, to
secure performance, and to punish the
breaching party if the deterrent is
ineffective.
Consistent with the principle of reasonableness, New Jersey courts have viewed enforceability of stipulated damages clauses
as depending on whether the set amount "is a reasonable forecast
of just compensation for the harm that is caused by the breach"
and whether that harm "is incapable or very difficult of accurate
estimate." Westmount Country Club, supra, 82 N.J. Super. at 206;
accord Monmouth Park Ass'n v. Wallis Iron Works,
55 N.J.L. 132,
140-41 (E. & A. 1892); Wood v. City of Ocean City,
85 N.J. Eq. 328, 330 (Ch. 1915); see 218-220 Market St. Corp. v. Krich-Radisco, Inc.,
124 N.J.L. 302, 305 (E. & A. 1939).
Uncertainty or difficulty in assessing damages is best
viewed not as an independent test, Calamari and Parillo, supra, §
14-31 at 641; Goetz & Scott, supra,
77 Colum. L. Rev. at 559
(stating, "liquidated damages provisions have seldom been voided
solely because the damages were easy to estimate"), but rather as
an element of assessing the reasonableness of a liquidated
damages clause, Wassenaar, supra, 331 N.W.
2d at 363. Thus,
"[t]he greater the difficulty of estimating or proving damages,
the more likely the stipulated damages will appear reasonable."
Ibid.
Some courts in other jurisdictions have also considered whether the parties intended the clause to be one for liquidated damages. Clarkson, supra, 1 978 Wis. L. Rev. at 353. Even those courts recognize that "subjective intent has little bearing on whether the clause is objectively reasonable." Wassenaar, supra, 331 N.W. 2d at 363. For the past eighty years, New Jersey courts have relied on the "circumstances of the case and not on the
words used by the parties" in determining the enforceability of
stipulated damages clauses. Gibbs v. Cooper,
86 N.J.L. 226,
227-28 (E. & A. 1914); see also Farnsworth, supra, § 12.18 at 939
("the parties' own characterization of the sum as 'liquidated
damages' or as a 'penalty' is not controlling"); Clarkson, supra,
1
978 Wis. L. Rev. at 353 (same); cf. Monmouth Park Ass'n, supra,
55 N.J.L. at 141 (stating, "if it be doubtful on the whole
agreement whether the sum is intended as a penalty or as
liquidated damages, it will be construed as a penalty, because
the law favors mere indemnity"). We conclude that the parties'
characterization of stipulated damages as "liquidated damages" or
as a "penalty" should not be dispositive.
Although the Appellate Division has indicated that courts
should determine the enforceability of a stipulated damages
clause as of the time of the making of the contract, Westmount
Country Club, supra, 82 N.J. Super. at 206, the modern trend is
towards assessing reasonableness either at the time of contract
formation or at the time of the breach. Calamari & Perillo,
supra, § 14-31 at 642 (stating, "there are two moments at which
the liquidated damages clause may be judged rather than just
one").
Actual damages, moreover, reflect on the reasonableness of the parties' prediction of damages. "If the damages provided for in the contract are grossly disproportionate to the actual harm sustained, the courts usually conclude that the parties' original
expectations were unreasonable." Wassenaar, supra, 331 N.W.
2d at
364; see 5A. Corbin on Contracts § 1063 (1951) (Corbin) ("It is
to be observed that hindsight is frequently better than
foresight, and that, in passing judgment upon the honesty and
genuineness of the pre-estimate made by the parties, the court
cannot help but be influenced by its knowledge of subsequent
events."). Determining enforceability at the time either when
the contract is made or when it is breached encourages more
frequent enforcement of stipulated damages clauses. Calamari &
Perillo, supra, § 14-31 at 642.
Two of the most authoritative statements concerning
liquidated damages are contained in the Uniform Commercial Code
and the Restatement (Second) of Contracts, both of which
emphasize reasonableness as the touchstone. Farnsworth, supra,
§ 12.18 at 938. Thus, section 2-718 of the Uniform Commercial
Code, adopted in New Jersey as N.J.S.A. 12:2-718, provides:
(1) Damages for breach by either party
may be liquidated in the agreement but only
at an amount which is reasonable in the light
of the anticipated or actual harm caused by
the breach, the difficulties of proof of
loss, and the inconvenience or non-feasibility of otherwise obtaining an
adequate remedy.
Similarly, the Second Restatement of Contracts provides:
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.
[Restatement (Second) of Contracts § 356(1)
(1981).]
Consistent with the trend toward enforcing stipulated damages clauses, the Appellate Division has recognized that such clauses should be deemed presumptively reasonable and that the party challenging such a clause should bear the burden of proving its unreasonableness. Central Steel Drum Co. v. Gold Cooperage, Inc., 200 N.J. Super. 251, 265 (concluding "that in the context of commercial parties having comparable bargaining power there should be presumptive validity of a liquidated damage clause"), certif. denied, 101 N.J. 303 (1985), overruled on other grounds, Kutzin v. Pirnie, 124 N.J. 500 (1991); see also J.L. Davis & Assocs. v. Heidler, 263 N.J. Super. 264, 274-75 (App. Div. 1993) (determining that "the party being assessed liquidated damages has the burden 'to offer proof of contractually acceptable excuses in order to avoid the application of the liquidated damage clause'") (quoting Monsen Eng'g Co. v. Tami-Githens, Inc., 219 N.J. Super. 241, 250 (App. Div. 1987)). But see Utica Mut. Ins. Co. v. DiDonato, 187 N.J. Super. 30, 42-43 (App. Div. 1982) (holding that party advocating enforcement of stipulated damages clause has burden of proof and persuasion). Similarly, most courts today place the burden on the party challenging a
stipulated damages clause. Calamari & Perillo, supra, § 14-31 at
643; see, e.g., Mattvidi Assocs. v. Nationsbank of Va.,
639 A.2d 228, 238 (Md. Ct. Spec. App. 1994) (noting that "[n]ot only is
placing the burden of proof on the party seeking to invalidate a
liquidated damages clause the majority rule, it is also the only
rule consistent with normal principles of contract law"); Haromy
v. Sawyer,
654 P.2d 1022, 1023 (Nev. 1982) (observing that
"[g]enerally, liquidated damage provisions are prima facie
valid"); Wassenaar, supra, 331 N.W.
2d at 367 (determining that
"the party challenging the contract[] carries the burden of
proving that the stipulated amount of damages is grossly
disproportionate to the actual harm and thus unreasonable").
Thus, the party challenging a stipulated damages clause "must
establish that its application amounts to a penalty." Haromy,
supra, 654 P.
2d at 1023.
In commercial transactions between parties with comparable bargaining power, stipulated damage provisions can provide a useful and efficient remedy. See Priebe & Sons v. United States, 332 U.S. 407, ___, 86 S. Ct. 123, 126, 92 L. Ed. 32, ___ (1947) (observing that "[t]oday the law does not look with disfavor upon 'liquidated damages' provisions in contracts[] [w]hen they are fair and reasonable attempts to fix just compensation for anticipated loss caused by breach"). Sophisticated parties acting under the advice of counsel often negotiate stipulated damages clauses to avoid the cost and uncertainty of litigation. Such parties can be better situated than courts to provide a fair
and efficient remedy. Absent concerns about unconscionability,
courts frequently need ask no more than whether the clause is
reasonable. We do not reach the issue of the enforceability of
liquidated damage clauses in consumer contracts. Notwithstanding
the presumptive reasonableness of stipulated damage clauses, we
are sensitive to the possibility that, as their history
discloses, such clauses may be unconscionable and unjust. Foont-Freedenfeld Corp. v. Electro-Protective Corp.,
126 N.J. Super. 254, 258 (App. Div. 1973), aff'd o.b.,
64 N.J. 197 (1974);
Westmount Country Club, supra, 82 N.J. Super. at 206; Goetz &
Scott, supra,
77 Colum. L. Rev. at 588 (stating that "in the
absence of bargaining unfairness, a stipulated damage clause
reflects equivalent value").
The purpose of a stipulated damages clause is not to compel the promisor to perform, but to compensate the promisee for non-performance. Farnsworth, supra, § 12.18 at 936. Accordingly, provisions for liquidated damages are enforceable only if "the amount so fixed is a reasonable forecast of just compensation for the harm that is caused by the breach." Westmount Country Club, supra, 82 N.J. Super. at 206; see also Restatement (Second) of Contracts, supra, § 356 comment a (stating, "The parties to a contract may effectively provide in advance the damages that are to be payable in the event of breach as long as the provision does not disregard the principle of just compensation."). One injured by a breach of contract is entitled
only to just and adequate compensation. McDaniel Bros. Constr.
Co. v. Jordy,
195 So.2d 922, 925 (Miss. 1967). Thus, the
subject cancellation clause is unreasonable if it does more than
compensate plaintiffs for their approximate actual damages caused
by the breach.
Whether measured from the time of execution of the contract
or from the termination of the lease, see Westmount Country Club,
supra,
81 N.J. Super. 206, damages based on gross receipts run
the risk of being found unreasonable. Generally speaking, gross
receipts do not reflect actual losses incurred because of the
cancellation. Gross receipts, unlike net profits, do not account
for ordinary expenses; nor do they account for the expenses
specifically attributable to the breach. Here, we cannot
determine whether the stipulated amount was based on damages that
would likely flow from a breach or whether it is an arbitrary
figure unrelated to any such damages.
A dearth of authority in this state compels us to consider opinions from other states. In Peerless Enterprises, Inc. v. T.N.T., Inc., 511 P.2d 538 (1973), the Colorado Court of Appeals upheld the trial court's conclusion that a stipulated damages provision based on gross receipts "did not bear a reasonable relationship to the actual losses which were likely to be suffered by plaintiff and that the clause was therefore a penalty clause." Id. at 539. The plaintiff, a vending machine operator, sued the defendant, a bar owner, to collect on a stipulated
damages clause included in a vending-machine-supply contract.
Halfway through the term of the contract, the defendant cancelled
the agreement. The clause provided that on cancellation, the
plaintiff would be entitled to an amount equal to the monthly
gross receipts from the machines for the duration of the contract
period. In rejecting the clause, the court held that "[g]ross
receipts do not bear a close enough relationship to the probable
loss suffered by plaintiff to justify the enforcement of the
clause in question as a liquidated damages provision." Ibid.
Similarly, in A.V. Consultants, Inc. v. Barnes,
978 F.2d 996
(1992), the Seventh Circuit refused to enforce a stipulated
damages provision in a contract between the plaintiff consulting
firm and the City of Gary, Indiana. The clause provided that if
the City terminated the agreement, it would still be responsible
for paying the plaintiff the balance of the administrative fees
due for the remainder of the contract term. Under the clause,
the City would have to pay the plaintiff as if the plaintiff were
still rendering a service. The court regarded the clause as
providing for an unenforceable penalty, reasoning that if the
clause were to be enforced, the plaintiff would recover doubly:
it "would be receiving its expected profit plus the value of its
services -- services AVC was free to sell elsewhere." Id. at
1001. "These damages would certainly be disproportionate to
AVC's loss." Ibid.
Courts also have disapproved the use of gross receipts as a
measure of damages apart from stipulated damages clauses. In a
Colorado case involving a landlord's breach of a lease, the trial
court allowed the jury to determine damages based only on the
tenant's loss of gross profits. The Supreme Court of Colorado
reversed, stating that "[g]ross profits do not furnish the proper
basis for damages for loss of business. . . . Damages sustained
by a business must relate to loss of net profits; they may not be
speculative, remote, imaginary, or impossible of ascertainment."
Lee v. Durango Music,
355 P.2d 1083, 1087 (1960).
Evaluating damages based on gross income is problematic
partly because such damages would be too speculative or
uncertain. Garcia v. Mountain States Tel. & Tel. Co.,
315 F.2d 166, 168-69 (10th Cir. 1963). Assessing damages only from gross
receipts has been described as an exercise in "pure guess and
speculation." Id. at 169; see also Williams v. Bone,
259 P.2d 810, 812 (Idaho 1953) (lamenting that damages ascertained only
from gross receipts "is so uncertain and speculative as to what
the loss might be, if any, that it is not a proper criterion in
fixing the loss"); Kenford Co. v. County of Erie.,
502 N.Y.S.2d 131, 132 (Ct. App. 1986) (ruling that damages from breach of
contract "may not be merely speculative, possible or imaginary").
Likewise, in Rainbow Island Productions, Ltd. v. Leong,
351 P.2d 1089 (1960), the Supreme Court of Hawaii found that because
the operating costs of plaintiff's motion picture corporation
were forty-percent of gross income, damages for interruption of
the business could not be determined by total gross revenues.
See also Lockwood Grader Corp. v. Backhaus,
270 P.2d 193, 199
(Col. 1954) (stating that proof of gross receipts is insufficient
and that "[w]ithout proof of profits there is no proof of
damages"); Williams, supra, 259 P.
2d at 811-12 (observing "there
is [no] authority to the effect that the jury could fix
compensatory damages from evidence showing only gross income
without deduction of expenses and costs of operation, from which
the net profits or decrease in net income could be determined").
Furthermore, basing damages on gross profits could award the
plaintiff a windfall. See Perico, Ltd. v. Ice Cream Indus.,
Inc., 1
990 WL 11539, at *6 (S.D.N.Y. Feb. 9, 1990) (holding that
"[t]o award plaintiff the gross receipts it expected from
customers . . . would be to confer an unwarranted windfall");
Jerry Alderman Ford Sales, Inc. v. Bailey,
291 N.E.2d 92, 105 n.6
(Ind. App. 1972) (stating, "Gross income is an improper measure.
Plaintiff should not receive a windfall in the form of that
portion of lost gross income representing expenses of operation
saved by defendant's breach.").
We cannot determine from plaintiffs' gross receipts the losses they sustained because of the Township's cancellation of the lease. The subject clause requires the Township to pay damages of twenty-five percent of the lessee's average gross receipts for one year. Under the lease, average gross receipts
are calculated by taking an average of the lessee's total gross
receipts for three fiscal years immediately preceding the
cancellation. So calculated, Jo-Ro's average yearly gross was
$1,161,240.75. Twenty-five percent of this figure amounts to
$290,310.18.
This amount, however, does not necessarily reflect
plaintiffs' actual losses on considering operating expenses or
relocation costs and other expenses attributable to defendant's
breach. As reflected in Jo-Ro's income-tax returns, Jo-Ro earned
a net profit of $3,649 in 1985, $414 in 1986, and sustained a
loss of $323 in 1987. We recognize the difference between tax
losses and actual losses. Yet, to the extent that tax returns
reflect actual profit or loss, they demonstrate the
unreasonableness of damages exceeding $290,000, which were
calculated on the basis of gross receipts.
The decision whether a stipulated damages clause is
enforceable is a question of law for the court. 218-220 Market
St. Corp., supra, 124 N.J.L. at 304; Robinson v. Centenary Fund,
68 N.J.L. 723, 725-26 (E. & A. 1902). Although the question is
one of law, it may require resolution of underlying factual
issues. Highgate Assocs., Ltd. v. Merryfield,
597 A.2d 1280,
1282 (Vt. 1991).
On balance, we believe we should remand this matter to the trial court to consider the reasonableness of the clause in light
of this opinion. In resolving that issue, the court should
consider, among other relevant considerations, the reasonableness
of the use of gross receipts as the measure of damages no matter
when the cancellation occurs; the significance of the award of
damages based on twenty-five percent of one year's average gross
receipts, rather than on some other basis such as total gross
receipts computed for each year remaining under the lease; the
reasoning of the parties that supported the calculation of the
stipulated damages; the lessee's duty to mitigate damages; and
the fair market rent and availability of replacement space. We
leave to the sound discretion of the trial court the extent to
which additional proof is necessary on the reasonableness of the
clause. Because stipulated damages clauses are presumptively
reasonable, supra at ___ (slip op. at 19-20), the burden of
production and of persuasion rests on the Township.
To summarize, we affirm the judgment of the Appellate
Division that the Township is liable to plaintiffs for
terminating the lease. The agreement did not violate N.J.S.A.
40:60-42, and N.J.S.A. 40A:12-14 does not apply retroactively to
the lease. We also affirm the judgment of the Appellate Division
awarding plaintiffs damages of $55,748.27 for renovation costs.
We remand to the Law Division the issue whether the clause
requiring payment of stipulated damages based on the lessee's
gross receipts is a valid liquidated damages clause.
The judgment of the Appellate Division is affirmed in part,
reversed in part, and the matter is remanded to the Law Division.
Chief Justice Wilentz and Justices Clifford, Handler,
O'Hern, Garibaldi, and Stein join in this opinion.