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