Colorado Court Of Appeals Weighs In On Contractual Liquidated Damages Clauses – And How It May Impact Franchise Agreements

Many franchise systems use liquidated damages provisions in their franchise agreements, particularly in relation to franchisee defaults. The validity and enforceability of these liquidated damages clauses are often hotly litigated in disputes between the franchisor and franchisees. Franchisors whose franchise agreements are governed by Colorado law may have gotten a boost from a recent Colorado case involving, in true Colorado fashion, a dispute over the purchase of ski condos.

In Ravenstar LLC v. One Ski Hill Place LLC, a builder of ski condos entered into a series of contracts with purchasers where the purchasers put down significant money deposits. The builder’s contract contained a liquidated damages provision which gave the builder the option to either take “all or part” of the deposit as liquidated damages or choose to sue for actual damages if the purchasers defaulted.

When a default occurred, the builder chose to take the deposits as liquidated damages, and the purchasers challenged the validity of the liquidated damages provision, arguing that the option contained in the provision made it unenforceable under Colorado law.

While addressing this rather narrow question, the Colorado Court of Appeals re-affirmed the validity of liquidated damages clauses, noting the three required elements under Colorado law: (1) the parties intended to liquidate damages; (2) when the contract was made, the amount of liquidated damages was a reasonable estimate of present and actual damages; and (3) at the time of the contract, it is difficult to ascertain the amount of actual damages that may result from a breach. In a typical franchise agreement, these essential elements are usually met through a creative drafting and the circumstances of a new franchise arrangement where damages are often very difficult to predict.

In the Ravenstar case, the purchasers argued that the existence of the option for the builder to choose at the time of breach whether to take liquidated damages or sue for actual damages indicated that the parties did not “intend to liquidate damages,” the first required element. Although the Court acknowledged that different states have reached different results on this question, the Court held that Colorado law would join those states that enforce liquidated damages clauses, even if those clauses give an option to one party to either take liquidated damages or not. The Court concluded that the builder could enforce the liquidated damages provision and keep the deposits, even though the provision contained an option for the builder.

Although the precise holding is somewhat narrow and relates to the purchase of ski condos, the case provides additional reinforcement to franchisors seeking to enforce liquidated damages provisions in their agreements. The Court clearly reaffirmed the validity of liquidated damages provisions under Colorado law, and ruling may provide additional tools for a franchisor to build an option into its franchise agreement, perhaps giving the franchisor similar options to either pursue liquidated damages or not in the event of a franchisee default. Given the cost of litigation and the sometimes-shaky financial situation of some franchisees, the ability of the franchisor to choose and enforce liquidated damages can continue to be a powerful tool under Colorado law.

The Colorado for appeals addressed a liquidated damages provision in contracts to purchase to be built the condos from a developer. The key issue involves the liquidated damages provision which gave builder the option of keeping some or all of the deposit as liquidated damages or moving to sued for actual damages under the contract. In an attempt to avoid the consequences of a liquidated damages provision, purchasers alleged that the fact that liquidated damages provision contained option rendered unenforceable under Colorado law.