Summary of Lake River Corp. v. Carborundum Co.
U.S. Ct of App. 1985
Facts: Carborundum manufactures Ferro Carbo an abrasive powder used in making steel. Carb entered into a contract with Lake River by which Lake River agreed to provide distribution services in its warehouses in Illinois. Lake River would receive Ferro Carbo in bulk from Carb’s bag it and ship it to Carbo’s customers. Carbo insisted that Lake River install a new bagging system to handle the contract. It cost $89000. To cover the cost and make a 20% profit Lake River insisted on a minimum guarantee clause. If the full minimum quantity was shipped Lake River would make $533000. Carborundum only shipped 12000 of the 22500 tons of the Ferro Carbo when the contract expired. Carbor had paid for the amount billed and bagged. The clause left Carborundum owing $241000, $533000 (ferro shipped) minus what Carborundum had paid. Lake retained 500 tons of bagged Ferro($31000).
Issue: Whether the formulae in the minimum guarantee clause imposes a penalty for breach of contract or is merely an effort to liquidate damages?
Holding: This clause is a Penalty Clause.
Procedure: The district ct bench trial gave judgment to both parties. Carborundum $42000($269000 +$31000 -$241000-$17000[prejudgment interest]). Remanded.
Rule: Liquidated damages must be a reasonable estimate at the time of contracting of the likely damages from breach, and the need for estimation at that time must be shown by reference to the likely difficulty of measuring the actual damages from breach after the breach occurs.
Full contract price minus the amount invoiced equals the gravity of breach.
Ct. Rationale: When a contract specifies a single sum in damages for any and all breaches even though it is apparent that all are not of the same gravity, the specification is not a reasonable effort to estimate damages; and when in addition the fixed sum greatly exceeds the actual damages likely to be inflicted by a minor breach, its character becomes a penalty. From the face of the contract the damages provided for by liquidated damages are grossly disproportionate to any probable loss and penalizes some breaches more heavily than other regardless of cost.
The unpaid contract price ($241000) minus the costs saved by not having to complete the contract (the variable costs on the other 45 % of the Ferro that it never had to bag).
PLA: The guarantee clause discourages willful breaches and “guarantees," that the non-breaching party is able to make its profit, minus mitigating cost. This clause insures against non-credible parties entering into contracts.
Def A: The provision is greatly disproportionate. The fixed sum greatly exceeds the actual damages inflicted by a breach.