Cover, Consequential Damages, and an Eight-Figure Penalty Clause
On January 5, Buyer contracts with Supplier for 10,000 custom microchips at $12 each, delivery by March 1. The chips are specially fabricated for Buyer's medical device. The contract states: 'If Supplier fails to deliver by March 1, Supplier shall pay Buyer $5 per chip per day of delay as liquidated damages, not as a penalty.' Supplier delivers on March 21, twenty days late, because Supplier diverted Buyer's production slot to a more profitable customer. Buyer had a contract to resell the devices for $200,000 profit, which it loses because it cannot assemble the devices without the chips. Buyer covers by buying 10,000 comparable chips from another supplier at $18 each on March 5. Buyer sues for $60,000 cover difference, $200,000 lost profits, and $1,000,000 liquidated damages. Supplier argues the clause is an unenforceable penalty and that the lost profits are too remote. Buyer's total contract price was $120,000.
1. Is the liquidated damages clause enforceable? Explain the UCC analysis.
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Liquidated damages or penalty
UCC § 2-718(1) enforces a liquidated-damages clause only if the amount is reasonable in light of the anticipated or actual harm, the difficulties of proof, and the inconvenience of otherwise obtaining an adequate remedy. The label 'not as a penalty' is not controlling. At contracting, the parties could reasonably anticipate that late delivery of custom medical-device chips would cause hard-to-quantify losses. But the amount is $5 per chip per day: for 10,000 chips, $50,000 per day; after 20 days, $1,000,000 against a $120,000 contract price. That is roughly eight times the contract price and far exceeds any plausible forecast of delay loss. A court would likely hold the clause an unenforceable penalty. Because the UCC does not generally blue-pencil, Buyer cannot enforce the $1,000,000.
2. Can Buyer recover the cover difference and lost profits? How should the court avoid double recovery?
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Cover and consequential damages
Buyer may recover the cover difference under § 2-712: (18 - 12) x 10,000 = $60,000, if the cover was made in good faith and without unreasonable delay. March 5 is prompt. Buyer may also recover consequential damages under § 2-715 if they were foreseeable at contracting. Supplier knew the chips were custom-fabricated for a medical device, which makes delay losses foreseeable. If Buyer told Supplier about the resale contract or the time-sensitive nature of the device, the $200,000 lost profit is recoverable. If not, the court may still find lost profits foreseeable from the nature of the custom medical device, but the amount must be proved with reasonable certainty. Buyer cannot recover twice for the same loss; the cover difference and lost profits must be allocated to distinct losses. The $1,000,000 penalty is not recoverable.
3. If the clause is a penalty, what actual delay damages may Buyer recover?
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Actual delay damages
If the clause is a penalty, Buyer can still seek actual damages for delay, but only those proved and foreseeable. The diversion of the production slot was a breach. Buyer's actual losses are the extra cover cost and the lost resale profit, subject to mitigation and certainty. Buyer cannot recover an additional $1,000,000 simply because the clause was struck; that would give it the benefit of the unenforceable penalty. The court may also consider whether Buyer's cover was reasonable and whether it could have mitigated the lost resale.