## Facts

- Colonial at Lynnfield, Inc. owned and operated a hotel in Massachusetts and sought capital due to financial strain from renovation-related lost income and increased costs.
- Colonial and Colonial Associates (a purchasing group) executed an agreement under which Associates would buy a 49% interest in the hotel for $3,375,000.
- The agreement permitted an initial “market-testing” period; once Associates elected to proceed by issuing a Notice to Proceed, it became bound and subject to a $200,000 liquidated-damages clause upon buyer default.
- A closing date was set for June 1, 1981.
- On May 29, 1981, Associates requested an extension because it had not secured financing; Colonial refused, and the transaction did not close.
- In September 1981, Colonial entered a substitute deal with Lincoln National Development Corporation under which Lincoln would purchase 50% for $3.7 million, with a contingency permitting purchase of 49% for $3,626,000 if the mortgagee did not approve the 50% sale.
- Colonial sued for breach, seeking the $200,000 liquidated amount despite the later higher-priced transaction for the same 49% interest.

## Issues

1. Whether the $200,000 liquidated-damages clause was enforceable under Massachusetts law or was an unenforceable penalty because it was grossly disproportionate to Colonial’s actual damages.
2. Whether the district court erred in dismissing the defendants’ counterclaims.
3. Whether the agreement (including the liquidated-damages provision) had expired before the alleged default.

## Decision

- The First Circuit affirmed that Associates breached the agreement after issuing a Notice to Proceed and then failing to close.
- The First Circuit reversed the award of $200,000 in liquidated damages, holding the clause unenforceable as a penalty under Massachusetts law.
- The First Circuit affirmed judgment for Colonial on the defendants’ counterclaims.
- The case was left in a posture where Colonial could recover only actual damages, if any, rather than the stipulated sum.

## Legal Principles

- Under Massachusetts law, a liquidated-damages clause is enforceable only if, at contract formation, it represents a reasonable estimate of anticipated damages in circumstances where damages would be difficult to ascertain.
- When actual damages are readily calculable, courts may conduct a retrospective appraisal comparing actual loss to the stipulated amount.
- A stipulated sum that is unreasonably and grossly disproportionate to actual damages is treated as a penalty and is unenforceable; the non-breaching party is limited to actual damages.
- A replacement transaction that leaves the non-breaching party better off than performance would have can demonstrate that a large liquidated amount would operate as punishment rather than compensation.

## Conclusion

The First Circuit held that while the buyer breached the contract, the $200,000 liquidated-damages provision was an unenforceable penalty because it was grossly disproportionate to Colonial’s actual loss in light of the higher-priced substitute sale, limiting Colonial to actual damages and affirming rejection of the defendants’ counterclaims.


Colonial at Lynnfield, Inc. v. Sloan, 870 F.2d 761 (1st Cir. 1989)