Some issues to consider when implementing provisions regarding liquidated damages in transaction documents

Provisions regarding liquidated damages are commonly used as a remedy in non-disclosure agreements, shareholders’ agreements and share purchase agreements. The wording of these clauses is essential for the ability to claim compensation for damages in addition to the agreed liquidated damages. In a recent ruling, the Swedish Supreme Court has limited the ability to claim compensation for damages when liquidated damages have been agreed between parties. 

Liquidated damages are commonly used to sanction certain provisions in transaction documents, such as non-disclosure agreements, shareholders’ agreements and share purchase agreements. In the two latter types of transaction documents, liquidated damages are typically used to sanction matters such as confidentiality, non-solicitation and non-compete undertakings. The reason for including provisions regarding liquidated damages in relation to these types of undertakings is that it is difficult for the beneficiary of the undertaking to show actual economic loss in the event of breach of the undertakings. 

A recent ruling by the Swedish Supreme Court (NJA 2010 s. 629) dealt with a liquidated damages clause in an agreement between two parties concerning the handling of a master key to certain premises. The case is of interest since the court interprets the liquidated damages to be the only remedy and limits the compensation in accordance with the liquidated damages clause. The agreement between the parties in the case in question stipulated that if a certain master key were lost, the party responsible for the key should pay a fixed sum as compensation to the other party. Since the loss far exceeded the agreed liquidated damages, the claimant alleged that the clause did not regulate compensation for damages and that this should be paid in addition to the liquidated damages. The court ruled that the agreement was precise and clear and
that the breaching party had been correct in perceiving the clause to be a final regulation between the parties. Therefore, the court ruled that the agreement should be interpreted as a limitation of the ability to claim compensation in addition to the liquidated damages set out in the agreement.

It should, however, be noted that the judgment does not state a general rule but that any agreement must be interpreted with regard to the circumstances of each case. This demonstrates the importance of careful drafting and the need to consider if the liquidated damages should be the minimum or the maximum liability. It should also be noted that a contract term or condition may be modified or set aside by the court if, for example, such term or condition is unconscionable with regard to the content of the agreement or the circumstances at the time the agreement was entered into.

In practice, the burden of proof for loss is difficult to achieve, especially in respect of losses related to unpermitted use of confidential information. It is a basic principle that the burden of proof lies with the person claiming breach of contract and it is therefore essential to regulate the remedy in the event of unauthorized use when sensitive information is disclosed to the counterparty. A high contractual penalty (“avtalsvite” in Swedish) may sometimes seem aggressive, but it is ultimately the only sure way to simplify the burden of proof for loss suffered from one party’s breach of contract, as it is easier to prove a breach of contract than a loss suffered from, for instance, confidential information being inadmissibly disclosed. However, in the context of the recent Supreme Court ruling, the inclusion of a poorly drafted liquidated damages clause could serve as an aggressive limitation of liability clause on behalf of the party in breach. The most important lesson from the Supreme Court case, therefore, is the importance of complementing a liquidated damages clause with a provision stating that the party in breach will also be liable to pay damages in the event that the actual loss suffered by the non-breaching party exceeds the agreed amount of the liquidated damages.