Construction License Agreements
It is not uncommon for construction on one property to require access onto or across an adjacent property. In fact, the need is so common that, by statute, a court can compel a neighbor to grant a license for necessary repairs or improvements “upon such terms as justice requires”. RPAPL §881. More often, the parties negotiate a license agreement with the licensee providing insurance coverage, indemnifying the licensor, promising to restore the property to its original condition, and paying a negotiated fee. But how can the licensor incentivize the licensee to finish their work in a timely fashion? The answer, as tested in the recent First Department case Seymour v. Hovanian, can be a hefty liquidated damages provision.
Liquidated Damages
“Liquidated damages constitute the compensation which, the parties have agreed, should be paid in order to satisfy any loss or injury flowing from a breach of their contract”. Truck Rent-A-Ctr. v. Puritan Farms 2nd, 41 NY2d 420, 423 (1977). However, the parties cannot simply pick a number out of a hat. Liquidated damages are only available when “it would be difficult, if not actually impossible, to calculated the amount of actual damage” (id. at 424) and when “the amount liquidated bears a reasonable proportion to the probable loss and the amount of actual loss is incapable or difficult of precise estimation”. Id. at 425.
In short, grossly disproportionate damages act more like a penalty than compensatory damages. Penalties are unenforceable. Seymour at *3.
What Is Grossly Disproportionate?
The First Department in Seymour was tasked with answering the question — when do agreed upon probable damages cross the line and become a grossly disproportionate penalty?
The license agreement in Seymour required the licensee to obtain a temporary certificate of occupancy within 18 months. The parties agreed that after 18 months the licensee would pay liquidated damages of $1,000 per day for the licensor’s “loss of habitability” of their property.
Ultimately, the licensee never obtained a temporary certificate of occupancy and instead obtained their certificate of occupancy 318 days late. The licensor sued, seeking $318,000 in liquidated damages. Among other arguments, the licensee submitted an appraisal of the licensor’s property setting a rental value of $430 per day, or 43% of the liquidated damages. The licensee argued that based upon the lesser appraised rental value of the property, the liquidated damages were actually an unenforceable penalty.
Ultimately, the First Department held that liquidated damages, totaling 2.3x the actual rental value of the property, were not grossly disproportionate. In the court’s reasoning, the liquidated damages were a legitimate estimate of damages freely negotiated between parties represented by attorneys.
“In the absence of any countervailing public policy concerns, freedom of contract prevails in an arm’s length transaction between sophisticated parties”. Seymour, at *4.
Negotiating Your License Agreement
If you are a licensor, negotiating a deadline with a liquidated damages provision is a powerful tool to motivate the licensee to finish on time. Competent counsel will give you the best chance at ensuring your liquidated damages are hefty and motivational, but not construed as an unenforceable penalty.
Licensees are cautioned to treat liquidated damages provisions seriously. Hindsight will not always save you from a freely negotiated deal you later regret.