The United States Fifth Circuit Court of Appeal recently held that a liquidated damage provision in a maritime contract is enforceable in the case of International Marine, L.L.C., et al v. Delta Towing, L.L.C.

A. Background

In September 2006, International Marine, L.L.C. ("International Marine") purchased two tugboats from Delta Towing, L.L.C. ("Delta") for four million dollars after several months of negotiations. Throughout the negotiations International Marine was clear that the vessels would be used "in house" and would not be used to compete with Delta. Delta was hesitant to sell the vessels because it intended to use them to grow its business, but it ultimately agreed to sell them subject to its standard non-compete language.

The parties signed a Vessel Sales Agreement (VSA) which included a liquidated damage provision that provided in part for a $250,000 payment for each violation of the non-competition clause. This figure was subject to significant negotiation and its magnitude was significantly less than the $4,000,000 per violation starting figure.

Almost two years after the sale Delta discovered that the vessels had been chartered without Delta's knowledge in violation of the VSA. Delta demanded the liquidated damages amount multiplied by an alleged thirty-six charters that breached the VSA, which totaled $9 million. International conceded that it breached the contract by operating twenty-seven charters, but refused to pay.

B. Dispute

Delta sued International Marine in Texas state court for breach of the VSA. In response, International Marine, relying on a forum selection clause in the VSA, filed suit against Delta in federal court in Louisiana seeking a declaration that it had not breached the VSA and that the liquidated damage provision was an unenforceable penalty. Delta counterclaimed for breach of contract, seeking enforcement of the liquidated damage provision. The district court ruled in favor of Delta finding that the liquidated damage provision in the VSA was enforceable, but declined to resolve the issue of damages. International Marine appealed. The Fifth Circuit affirmed.

C. Discussion

When courts interpret maritime contracts federal admiralty law rather than state law applies. The burden of proving that a liquidated damages clause is a penalty is on the party urging it to be viewed as a penalty. Courts examine a liquidated damage provision to determine whether such a clause is "so unreasonable as to be a penalty." Two factors are considered: 

1. The anticipated or actual loss caused by the breach. 
2. The difficulty of proof of loss. 

The Court of Appeal noted that Delta was concerned about competition and International Marine's assurance that it would not compete with Delta was critical in the negotiations that led to the sale of the vessels. The Fifth Circuit found that the trial court correctly assessed expert testimony regarding potential contracts that Delta could have obtained and corresponding charter rates. It concluded that a single contract could reasonably generate substantial revenue equal to or in excess of the liquidated damage provision ($250,000). The Fifth Circuit further held that International Marine failed to carry its burden of proving that the liquidated damage provision was a penalty.

D. Why is this important?

1. A liquidated damage provision can create significant liability - twenty seven breaches at $250,000 per occurrence equates to $6,750,000 in liquidated damages.
2. Arguments can be advanced to defeat a liquidated damage clause in a maritime contract, but the party advancing it has the burden of proof.
3. Expert testimony may be needed to support the reasonableness of the amount of a liquidated damage provision should a dispute arise.