Liquidated damage clauses, which establish the amount of damages to be paid in the event of a breach or cancellation of a contract, have become a standard part of hotel agreements. They can benefit both sides of a contract, but they can also be abused. Meeting executives need to negotiate these clauses carefully to minimize their potential negative impact.

A liquidated damage clause is frequently mistaken for a "penalty" provision, but they are different. First, penalties for cancellation of a contract are barred by law. Second, liquidated damage clauses are designed to reimburse, or "make whole," the nonbreaching party for any loss--not to penalize the breaching party.

If a provision sets damages for breach of a contract so large as to be characterized as a penalty, it will be disregarded by the courts. The reasonableness of a contractually established amount of damages may not always be obvious, however, since in most cases liquidated damage clauses are present because the anticipated damages from a breach of contract are difficult to prove.

The Double-Dip Deal Under the concepts of traditional contract law, the nonbreaching party must take reasonable actions to ensure that the damages caused by the breach are minimized. In the hotel contract scenario, for example, the hotel has a duty to attempt to resell canceled rooms and must make a good-faith effort to do so.

If the hotel contract contains a liquidated damage clause, the hotel recovers liquidated damages under the contract and can resell the rooms that were previously reserved for the breaching party. In essence, the liquidated damage clause replaces the common law duty to mitigate and may prove a useful tool to the parties by establishing a clear calculation of damages while avoiding the often lengthy litigation involved in proving it.

However, to the party paying the liquidated damages it may seem as if the hotel is enriched by the cancellation. The hotel gets the liquidated damages and, at the same time, still has the ability to resell the canceled rooms.

In essence, some think that liquidated damage clauses allow hotels to "double dip" by reselling the rooms they are being compensated for under the liquidated damage clause. Although some liquidated damage clauses may have that effect, a well- structured clause can work to the benefit of both parties.

One solution to the double-dipping issue is to have a liquidated damage provision that reflects adjustments to be made for mitigation, and that requires the hotel to mitigate if the contract is canceled. Here is an example of such a provision:

Hotel shall undertake all reasonable efforts to resell canceled rooms, and will credit those revenues against the liquidated damages in an amount not to exceed the full amount of such damages. Liquidated damages, if any, shall be due and payable X days after [original meeting date] provided the Hotel provides proof of its efforts to mitigate damages and proof that rooms being held for Group's attendees were unsold.

Other Safeguards It is often difficult to prove that any rooms sold after the cancellation were rooms that had been contracted for by the parties. One solution is to include within the liquidated damage clause an average occupancy rate for the hotel, which can be used in determining if there was any mitigation after cancellation. The actual occupancy rate measured against the contractually determined occupancy rate could then be used as the formula for determining any offset against the liquidated damages.

Another potential issue is that liquidated damage provisions often apply only to the situation in which a group cancels its meeting. But what if the hotel cancels the group's reservations? It has been known to happen. And the difficulty in assessing the canceled group's costs probably is even greater than calculating the hotel's loss from cancellation.

Liquidated damage clauses can be the solution to that problem. If they are drafted to apply to any breach or cancellation, then both parties will have a clear understanding of their obligations, and a group, should its reservations be canceled, will know exactly what it is entitled to from the hotel.

By establishing a duty to mitigate (and setting an average occupancy rate as a basis for determining damages) and by making liquidated damage clauses apply to all breaches and cancellations, liquidated damage clauses can provide certainty and fairness for both parties.*