Delaware Business Lawyer Blog

Every state has a law called the “statute of limitations” which says how many years you have to file a lawsuit. In Delaware, the statute of limitations for breach of contract cases is 3 years from the date the claim “accrued.” In most cases, the date the claim accrued is the date the contract was breached.

The reason why there’s a statute of limitations is to prevent stale claims from being brought to court so that a person doesn’t have to worry for the rest of his life about being sued for something that happened a long time ago. Imagine how difficult it might be to defend a case after a long period of time has gone by where witnesses die or move away, and documents get lost.

In Delaware, in order to win a lawsuit based on quantum meruit, you have to prove 4 things: (1) you provided or performed a valuable service; (2) the service was provided to the defendant (the person you are suing); (3) the service you provided was requested by the defendant and accepted by him; and (4) the services were provided by you under circumstances that put the defendant on notice that you expected him to pay for your services.

Based on principals of fairness, the concept of quantum meruit recognizes that a person would be “unjustly enriched” if he were permitted to receive a benefit such as labor or materials and not pay for it.

It’s for this reason that we insert a liquidated damages clause in the contract. Let’s not get hung up on terminology. The term “liquidated damages” means that the amount of the dollar loss is known. For example, if XYZ Company promises to pay $50,000 for a shipment, and fails to do so, the amount owed is known. You don’t have to provide evidence that will enable the court to calculate the loss. It’s $50,000. On the other hand, the term “unliquidated damages” means that the amount of the loss is not known. For example, if you purchase an existing business and the contract has a provision prohibiting the seller from competing with you, the amount of your loss could be extremely difficult to prove if the seller opens up a competing business. Think about how you might prove in court under strict rules of evidence the amount of money you will lose because the seller is competing with you.

This is where the concept of liquidated damages comes in. It involves agreeing upon an amount, at the time you enter into the contract, that the other party must pay you if he breaches the contract. It turns what are unliquidated (unknown) damages into liquidated (known) damages.

You cannot use the concept of liquidated damages as a penalty to be imposed on a party for breaching a contract. Instead, the amount has to be a good faith estimate of the damages that would actually be sustained. If the Court determines that the amount in the contract is intended as a punishment for defaulting, it’s considered a penalty and will not be enforced. If that occurs, you could be faced with the difficult if not impossible task of proving the actual damages you sustained.

The Courts in Delaware have established the following test to determine whether the amount inserted in the contract is a penalty or liquidated damages. To be a valid liquidated damages clause, at the time you enter into the contract the amount of damages you might reasonably expect to suffer must be difficult to ascertain because of their indefiniteness or uncertainty. In addition, the amount both parties stipulate to has to be a reasonable estimate of the damages which would probably be caused by the breach.

Just last month, the Delaware Court of Chancery issued an opinion that was based on the Statute of Frauds. As a result, the plaintiff lost out on the chance to receive hundreds of millions of dollars in retirement payments. That’s right - hundreds of millions of dollars!

The lawsuit was brought by Brian Olson, one of the founders of a hedge fund who was removed from his position by his co-founders. Olson claimed that he was entitled to substantial payments under the terms of their LLC operating agreement. The problem was that the operating agreement had never been signed. Olson claimed that the unsigned operating agreement reflected what had been orally agreed upon, and that oral agreements are enforceable. His co-founders claimed that they had never reached a final agreement on the terms.

The Court was faced with deciding whether an oral LLC operating agreement was enforceable. First, the Court recognized that oral operating agreements are permitted under Delaware’s LLC statute. Next, the Court reviewed the statute of frauds which states that an agreement that can’t be performed within one year has to be in writing and signed in order for it to be enforced. On the other hand, if the oral contract may by any possibility be performed within a year, then the contract is enforceable.

The Court then pointed out that few LLC operating agreements contain any provision that can’t be performed with one year, and so the statute of frauds wouldn’t limit the enforcement of that agreement. So far, so good for Olson. On the other hand, if the LLC operating agreement contains a provision that cannot possibly be performed within one year, then that provision is unenforceable.

Under the Delaware Statute of Frauds, a contract that requires more than 1 year for performance is not enforceable unless there’s evidence of a written agreement. On the other hand, if there’s any possibility of performing the contract within1 year, then the contract is enforceable even though there’s nothing in writing.

Delaware’s Statute of Frauds also applies to contracts for the sale of real estate. Simply stated, an oral agreement to purchase real estate in Delaware has to be in writing; otherwise it’s not enforceable. There is, however, an exception to this rule. An oral contract to purchase real estate can be enforced in Court if there’s been “part performance” of the contract.

In order to constitute part performance, the act has to be something that would not have been done unless there was in fact a contract. In Delaware, the Courts have found that the following acts can be considered part performance:

1. Making partial payment or full payment of the purchase price
2. Performing services that were agreed to be exchanged for the land
3. Making valuable improvements to the land

Let’s consider a case where one Delaware business owner sues another Delaware business owner for breach of contract. The written contract is, of course, admitted into evidence so the Court can see what the parties agreed to at the time they signed the contract. But what if one of the parties claims that he was promised something during the negotiations leading up to the contract, and that this promise was one of the main reasons why he entered into the contract?

Under these circumstances, the question for the Court to decide is whether that oral promise can be taken into consideration. In making this determination, the Court focuses on whether the written contract is clear and unambiguous, or whether it’s written in a way that’s subject to two or more reasonable interpretations. Applying what's called the "parol evidence rule," the Court will not allow the introduction into evidence of oral understandings or promises if the contract is clear and unambiguous.

I remember a case where a commercial tenant sued the landlord for more than $1 million because of a structural defect in the building that caused damage. Claiming that it was not responsible, the landlord tried to introduce evidence that when the lease was written, the tenant and the landlord had noticed a tilting wall, and they both agreed that the landlord would be responsible for the wall in case it needed to be fixed. What was written, however, was that the landlord would be responsible for "structural defects." Despite the landlord's argument that it's only obligation was to fix a tilting wall, the Court refused to consider any testimony about the wall because the language in the contract clearly and unambiguously provided that the landlord would be responsible for structural defects.

(1) "This Agreement shall be governed by and construed and enforced in accordance with the laws of the State of Delaware."
(2) "Neither party may assign this Agreement without the prior written consent of the other party hereto."
(3) "This Agreement constitutes the entire agreement between the parties, and supersedes all prior agreements, representations and understandings of the parties, written or oral."

Let's focus on the 3rd paragraph. While it may look okay, you'd be surprised how many lawsuits are decided based on this language. What usually happens is that one of the parties to the contract decides to sue for breach of contract. To support his claim, he tries to introduce evidence of oral statements and even emails that were exchanged during the contract negotiations. The question is then raised whether the court can consider that evidence when the contract clearly and unambiguously states that the contract contains the entire agreement between the parties.

Written contracts are more than just a formality you have to go through to move forward with the deal. The specific words in the contract you're about to sign are important, and they can come back to haunt you if you end up in court.

In some cases, it’s easy to prove damages. For example, you have a contract with a customer to pay you $75,000 for your services, and the customer fails to pay. However, in other cases, it can be difficult if not impossible to prove damages. A good example is where you buy a business, and you and the seller include in the purchase agreement a non-compete agreement prohibiting the seller from starting a business that competes with the one you just purchased. If the seller breaches the non-compete provision, how can you quantify and prove your financial losses that result from this breach? The answer, of course, is you really can’t.

Therefore, when you’re negotiating a contract, one of the important questions to consider is whether, in the event of a breach, you will be able to meet your burden of proving your damages to the satisfaction of a judge or a jury. With the help of an experienced Delaware business attorney, you can discuss that question at length, and protect yourself if it turns out that proving damages could, in fact, be a problem. The way to avoid having to prove damages is to insert a liquidated damages clause in your contract.

A liquidated damages clause is very simple. It states the amount of money both parties to a contract agree up front will be the loss sustained in the event the contract is breached. If you file a lawsuit and prove liability, you won’t have to prove your actual damages if the contract contains a valid liquidated damages clause.