On May 18, 2023, the First Department issued a decision in Atlantis Mgt. Group II LLC v. Nabe, 2023 NY Slip Op. 02737, holding that a liquidated damages clause was an unenforceable penalty, explaining:
Supreme Court correctly concluded that § 6.3 of the parties’ operating agreements (OAs) — the provision allowing plaintiff to buy back the interests of defendants Rajan and Rahul Nabe for $1.00 if the Nabes breached the operating agreements — was an unenforceable penalty. Section 6.3 was not a reasonable measure of the anticipated harm arising from a breach but was instead punitive in nature, serving to propel performance by the Nabes rather than to merely compensate for a loss. Furthermore, for a clause such as § 6.3 to be enforceable as liquidated damages, the liquidated amount must not only bear a reasonable proportion to the probable loss, but the amount of the actual loss must be difficult or impossible to precisely estimate. Here, however, the amount of actual damages was ascertainable, as evinced by the affidavit of plaintiff’s certified public accountant. Indeed, in the cause of action for breach of contract, plaintiff seeks actual monetary damages.
In addition, the buyback clause in § 6.3 violated public policy, as it grossly overcompensated plaintiff for any loss it may have sustained from a breach of contract. The operating agreements were negotiated at arm’s length by sophisticated businesspeople, and the Nabes received consideration for the buyback clause. Nevertheless, the principle that parties have freedom of contract may be overridden by a significant countervailing public policy, including a situation where, as here, a liquidated damages provision is grossly disproportionate to the actual damages.
We reject plaintiff’s assertion that the court misread § 6.3 in finding that any breach of the OAs triggered the buyback provisions. The court did not misread the clause at all; the clause makes clear that the triggering events for the buyback did, in fact, include any act in contravention of the OAs, without limitation. Thus, § 6.3, which imposes a draconian remedy for a trivial breach of contract, is a penalty rather than a liquidated damages clause, and we decline to enforce it.
Plaintiff cannot be heard to argue that the court’s determination was premature because discovery might reveal substantial damages that were, in fact, proportional to the buyback provision, as plaintiff itself chose to move for summary judgment before discovery was complete. In any event, whether a sum stipulated in an agreement represents liquidated damages or a penalty is a question of law.
(Internal citations omitted).