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RATTIGAN v. COMMODORE INTERN. LTD.

June 5, 1990

THOMAS J. RATTIGAN, PLAINTIFF,
v.
COMMODORE INTERNATIONAL LIMITED, DEFENDANT., COUNTERCLAIM PLAINTIFF,



The opinion of the court was delivered by: Mukasey, District Judge.

OPINION AND ORDER

Defendant Commodore International Limited moves for an order declaring § 9(a) of the employment agreement between plaintiff Thomas Rattigan and Commodore to be unenforceable as a penalty. For the reasons set forth below, defendant's motion is denied.

I.

The basic facts and contentions in this case have been set forth previously in the opinion and order denying summary judgment, issued on May 5, 1988. Familiarity with these facts and contentions is assumed.

Defendant argues that the section of plaintiff's employment agreement providing for the acceleration of contract benefits to Rattigan upon the occurrence of certain events is not an enforceable liquidated damages clause, but is an unenforceable penalty. Section 9(a) of the agreement provides that if Rattigan's employment is terminated for any reason other than his death, permanent disability, voluntary resignation — except for resignation as described in § 9(c) — or for cause, as described in § 9(b), Rattigan will receive an accelerated payment of his salary through May 31, 1991, all bonuses guaranteed in the contract, all retirement benefits guaranteed by the contract, and all the shares he would have received until the end of the contract term free of all restrictions.

Section 9(c) provides that if "Rattigan should resign his employment hereunder because of the occurrence of any of the following events described hereinbelow, such resignation shall not be deemed to be a voluntary resignation for the purposes of this Agreement, with the consequence that Rattigan will, under such circumstances, be entitled to the payments and benefits described in subsection a of Section 9 hereinabove." The circumstances which trigger § 9(a)'s payment provision include a material diminution or material change in the character of Rattigan's duties, a material change in the location where these duties are to be performed outside a 100-mile radius of certain major cities, a dissolution, liquidation or merger of Commodore, and certain changes in the controlling or principal shareholder of the company.

As set forth below, because § 9 of the employment agreement provides for damages in the event of certain material breaches which are not grossly disproportionate to the actual injury that Rattigan could sustain in the event of such a breach, the section will be enforced if the trier of fact determines that Rattigan's resignation was involuntary and without cause as defined in the agreement.

II.

Parties to a contract have the right, under New York law, to specify within a contract the damages to be paid in the event of a breach, so long as such a clause is neither unconscionable nor contrary to public policy. Truck Rent-A-Center, Inc. v. Puritan Farms 2nd, Inc., 41 N.Y.2d 420, 424, 393 N.Y.S.2d 365, 368-69, 361 N.E.2d 1015, 1017-18 (1977); Mosler Safe Co. v. Maiden Lane Safe Deposit Co., 199 N.Y. 479, 485, 93 N.E. 81, 83 (1910). If the clause "is intended by the parties to operate in lieu of performance, it will be deemed a liquidated damages clause and may be enforced by the courts. . . . If such a clause is intended to operate as a means to compel performance, it will be deemed a penalty and will not be enforced." Brecher v. Laikin, 430 F. Supp. 103, 106 (S.D.N.Y. 1977).

Although freedom of contract is at the core of contract law, the "freedom to contract does not embrace the freedom to punish, even by contract." Garrity v. Lyle Stuart, Inc., 40 N Y2d 354, 360, 386 N.Y.S.2d 831, 834, 353 N.E.2d 793, 796 (1976). A clause setting damages much higher than the estimated actual loss does not provide fair compensation, but secures "performance by the compulsion of the very disproportion. A promisor would be compelled, out of fear of economic devastation, to continue performance and his promisee, in the event of default, would reap a windfall well above actual harm sustained." Truck Rent-A-Center, 41 N.Y.2d at 424, 393 N.Y.S.2d at 369, 361 N.E.2d at 1018.

Thus, parties may agree upon damages in advance when the liquidated amount "is a reasonable measure of the anticipated probable harm," and the probable actual loss from a breach is difficult to estimate or ascertain at the time the contract is executed. Truck Rent-A-Center, 41 N.Y.2d at 425, 393 N.Y.S.2d at 369, 361 N.E.2d at 1018. See City of Rye v. Public Service Mut. Ins. Co., 34 N.Y.2d 470, 473, 358 N.Y.S.2d 391, 393, 315 N.E.2d 458, 459 (1974); Vernitron Corp. v. CF 48 Associates, 104 A.D.2d 409, 409, 478 N.Y.S.2d 933, 934 (Second Dep't 1984). The reasonableness of the liquidated damages and the certainty of actual damages both must be measured as of the time the parties enter the contract, not as of the time of the breach. Vernitron, 104 A.D.2d at 409, 478 N.Y.S.2d at 934. When a court sustains a liquidated damages clause, the measure of damages for a breach will be "the sum in the clause, no more, no less"; when a court strikes the clause as a penalty, the prevailing party is limited to actual damages proved. Brecher, 430 F. Supp. at 106.

Whether a provision is an enforceable liquidated damages clause or an unenforceable penalty is a matter of law to be decided by the court. Vernitron, 478 N.Y.S.2d at 934. Courts have tended, in doubtful cases, "to favor the construction which makes the sum payable for breach of contract a penalty rather than liquidated damages, even where the parties have styled it liquidated damages rather than a penalty." City of New York v. B & M Ferry Co., 238 N.Y. 52, 56, 143 N.E. 788 (1924).*fn1 Nevertheless, defendant has the burden of proving that the liquidated damage clause to which it freely contracted is, in fact, a penalty. See P.J. Carlin Construction Co. v. City of New York, 59 A.D.2d 847, 848, 399 N.Y.S.2d 13, 14 (First Dep't 1977); Harbor Island Spa, Inc. v. Norwegian America Line A/S, 314 F. Supp. 471, 474 (S.D.N.Y. 1970).

Commodore argues here that § 9(a) of Rattigan's employment contract operates as a penalty because it bestows upon Rattigan a sum disproportionate to any conceivable loss from the agreement's breach, and because it provides a windfall to Rattigan regardless of whether the breach is trivial or serious. Commodore asserts that if Rattigan involuntarily resigned immediately after signing the contract, and received the damages provided in the contract, he would be in a better position than if he continued to work for Commodore for the entire contract term. This argument technically is correct. Although the contract provides that 20 percent of Rattigan's 500,000 shares will vest free of restrictions each year, § 9(a) provides for accelerated vesting of all the shares free of restrictions. More important, § 9(a) does not require that the accelerated salary and bonuses be discounted to present value; thus, Rattigan would receive more under § 9(a)'s acceleration of certain benefits than he would receive under those benefits provisions in the contract.

Nonetheless, the liquidated damage provision is not "grossly disproportionate" to what the parties reasonably could estimate as the anticipated probable loss from breach at the time they signed the contract. First, Rattigan would have received other forms of compensation under the contract not conferred by the liquidated damages provision, but which might be taken into account in a calculation of actual damages for breach. For example, § 9(a) gives Rattigan accelerated payment of the two minimum bonuses of $200,000 that are guaranteed under § 4 of the contract, but Rattigan could well have received more than these two minimum bonuses during his tenure as Commodore's President and CEO. Further, § 5 of the contract entitles Rattigan to benefits such as medical, dental, accident and life insurance, an option to purchase a $1 million paid life insurance policy for the term of the employment period, the use of a company car, payment for club memberships, reimbursement for relocation expenses and suitable living ...


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