Purchase and Sale Agreement
Flip Deal
Escrow Account
Earnest Money
Due Diligence Period
Liquidated Damages Clause
Contract Drafting
Illinois Law
During 2014, Smart Oil’s sole member, Mehmood Syed, marketed for sale numerous properties with gas stations and convenience stores. After lengthy negotiations, Smart Oil and DWM executed a Purchase and Sale Agreement and Joint Escrow Instructions (the “Agreement”) by which DWM agreed to purchase thirty such parcels of real property for $67 million. Both parties were represented by counsel throughout the negotiations.
The Agreement requires DWM to initially deposit $300,000 into an escrow account. That deposit was to take place during a due diligence period following acceptance of the Agreement. The Agreement obliges the escrow account holder to transfer that deposit to the title company. Then, at the close of the due diligence period, DWM is to pay a second deposit of $450,000 to the title company. The total earnest money of $750,000 is about one percent of the total purchase price.
DWM never paid the initial earnest money deposit. Despite DWM’s failure to do so, the parties continued their due diligence investigations and negotiations. By the close of the due diligence period, the Agreement requires DWM to provide Smart Oil with written notice if, after its investigations, DWM disapproved of the purchase. If DWM had provided this written notice, the Agreement would have terminated, and the earnest money would have been returned to DWM. If DWM did not provide that written notice, section 4(a)(i) of the Agreement states that such “failure to timely deliver written notice of its disapproval shall be deemed Buyer’s approval of such investigations,” and Smart Oil would be entitled to keep the earnest money if the deal otherwise fell through. DWM asserts it negotiated with Smart Oil to lengthen the due diligence period, extending the time to provide written notice of disapproval. Regardless, DWM failed to provide written notice of disapproval, which DWM does not dispute. At the close of the due diligence period, DWM also did not pay the second deposit.
In the meantime, Syed contacted property owners about selling their properties to Smart Oil which would then sell them in the aggregate to DWM. This is known as a “flip deal,” and according to Smart Oil was contemplated under section 17(c) of the Agreement, which states in bold: “The parties acknowledge that Seller is the holder of a portfolio of gas station businesses, real estate and/or leases and only nominal title holder for purposes of transferring title to the Buyer.” To make good on its end of the Agreement, Smart Oil executed contracts with various property owners for the sale of their properties.
Ultimately, DWM failed to close under the terms of the Agreement and the parties’ deal fell through. The individual property owners did not sell their properties to Smart Oil under the individual contracts, and Smart Oil never flipped those properties to DWM.
Smart Oil sued DWM for breach of contract, arguing it was entitled to $750,000 in earnest money as liquidated damages under the following term: “If Buyer defaults in its performance ... under this Agreement, including the obligation of Buyer to purchase the Property if all conditions precedent to such obligations has been satisfied, Seller shall receive the entire Earnest Money Deposit and all accrued interest thereon as complete liquidated damages.” The Agreement explains the need for liquidated damages in conspicuous language: “IT BEING UNDERSTOOD THAT THE DAMAGE TO SELLER CAUSED BY ANY SUCH DEFAULT OF BUYER WOULD BE EXTREMELY DIFFICULT TO OR IMPOSSIBLE TO ASCERTAIN.” The liquidated damages clause survives termination of the contract per section 17(a). Both parties signed under that clause demonstrating their consent and agreement.
The district court ruled that Smart Oil satisfied all conditions precedent of the Agreement and that DWM breached the contract by not paying the earnest money. First, the court found that Smart Oil had authority to convey the properties, relying on numerous sworn statements from property owners verifying that they were ready to sell the properties to Smart Oil for Smart Oil to “flip” them to DWM. Second, the court found that DWM failed to give written notice of disapproval of the due diligence investigations, and that failure was “deemed Buyer’s approval of such investigations” under Section 4(a)(i) of the Agreement. Because DWM approved of the due diligence materials under the Agreement, Smart Oil satisfied its condition precedent for due diligence disclosures. So DWM’s obligation to pay the earnest money remained, and DWM admits it never paid.
The district court also held that Smart Oil was entitled to the earnest money as liquidated damages under Illinois law, noting that DWM’s representative signed the liquidated damages clause that explicitly stated actual damages would be extremely difficult or impossible to ascertain. The court found the liquidated damages figure to be a fair and reasonable amount and granted Smart Oil’s motion for summary judgment.
The Agreement includes a prevailing party attorneys’ fees and costs provision, under which the court granted fees and costs to Smart Oil.
Under Illinois law, a plaintiff suing for breach of contract must prove: (1) the contract existed, (2) the plaintiff performed the conditions precedent required by the contract, (3) the defendant breached the contract, and (4) damages. DeliverMed Holdings, LLC v. Schaltenbrand, 734 F.3d 616, 626 (7th Cir. 2013) (citing Law Offices of Colleen M. McLaughlin v. First Star Fin. Corp., 963 N.E.2d 968, 981 (Ill. App. Ct. 2011)).
Section 4 of the Agreement provides that DWM’s obligation to consummate the transaction is subject to the following conditions precedent for DWM’s benefit: (1) due diligence investigations and materials; (2) title insurance commitments for each of the properties; (3) inventories of the personal property for each of the businesses; and (4) that Smart Oil’s representations and warranties were truthful and accurate under Section 15 of the Agreement. DWM argues Smart Oil failed to satisfy two of these conditions: it did not have authority to convey the properties, and it failed to produce the requisite due diligence materials. Both arguments fail, however.
To prove Smart Oil had authority to execute the Agreement, Smart Oil provided sworn statements from owners of 21 of the 30 properties. They declared under penalty of perjury they were ready and willing to sell their properties to carry out the Agreement and that Smart Oil had authority to flip the properties to DWM.
Liquidated Damages
A liquidated damages clause provides a predetermined remedy in the event a party breaches. McNamara v. O’Donnell Haddad LLC, 2016 IL App (2d) 150519‐U, ¶28. “This predetermined amount may or may not exceed the actual damages and both parties agree to accept this inherent risk.” Id. An unreasonably large liquidated damages clause is unenforceable under Illinois law on grounds of public policy. Id. Liquidated damages clauses in real estate contracts are common to avoid the difficulty of proving damages by methods such as market value, resale value, or otherwise. Karimi v. 401 N. Wabash Venture, LLC, 2011 IL App (1st) 102670, ¶16 (citing Siegel v. Levy Organization Dev. Co., 538 N.E.2d 715, 717 (Ill. App. Ct. 1989)).
Whether a liquidated damages clause in a contract is a penalty or a valid provision is a question of law. Grossinger Motocorp, Inc. v. Am. Nat’l Bank & Trust Co., 607 N.E.2d 1337, 1345 (Ill. App. Ct. 1992). The burden of proof “rests on the party resisting enforcement of a liquidated damages clause to show that the agreed‐upon damages are clearly disproportionate to a reasonable estimate of the actual damages likely to be caused by a breach.” XCO Int’l, Inc. v. Pac. Sci. Co., 369 F.3d 998, 1003 (7th Cir. 2003).
“The reasonableness of the amount, though, depends not on the actual damages suffered by the non‐breaching party, but on whether the amount reasonably forecasts and bears some relation to the parties’ potential loss as determined at the time of contracting.”
Here, the Agreement states if DWM fails to purchase the properties, Smart Oil “shall receive the entire Earnest Money Deposit and all accrued interest thereon as complete liquidated damages.” The Agreement further explains the rationale for liquidated damages in conspicuous language that damages to Smart Oil caused by DWM’s default “WOULD BE EXTREMELY DIFFICULT TO OR IMPOSSIBLE TO ASCERTAIN.” Both parties signed immediately below the liquidated damages clause, demonstrating their consent and agreement to the provision.
Illinois “courts have considered earnest money representing up to 20% of the purchase price a reasonable sum as liquidated damages.” Karimi, 2011 IL App (1st) 102670, ¶24 (holding earnest money of 15% of the purchase price in real estate contract was reasonable liquidated damages); see, e.g., Siegel v. Levy Org. Dev. Co., 182 Ill. App. 3d 859, 860–63 (Ill. App. Ct. 1989) (holding earnest money of $320,000 on a $1,600,000 contract, representing two percent of the purchase price, was reasonable). One percent of the Agreement’s purchase price is not “clearly disproportionate” under XCO Int’l, Inc., 369 F.3d at 1003.
(…) The Agreement contains a clause shifting attorneys’ fees and costs to the prevailing party. Having prevailed on appeal, Smart Oil has 14 days to submit its requested attorneys’ fees and costs, and DWM has 14 days to respond.
(U.S. Court of Appeals for the Seventh Circuit, August 17, 2020, Smart Oil, LLC v. DW Mazel, LLC, Docket No. 19-2542)
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