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The McGuire Case: Alternative Performance or Penalty Provision?

The legal doctrine of “alternative performance” has been a valid theory of contract law for more than a century. Alternative performance, also known as “alternative contract” or “alternative-methods-of-performance contract,” is one in which the performing party may choose to perform one of two or more specified acts to satisfy the contractual obligation. An alternative contract provides more than one way for a party to complete his or her performance requirement. Alternative contract allows a party to choose the manner of performance, including the payment of a fixed sum of money instead of performance, without adhering to the required rules regarding liquidated damages clauses. Last October, in the case of McGuire v. More-Gas Investments, LLC (2013) (No. C067865, 3rd Dist. Oct. 15, 2013, 2013 Cal.App. LEXIS 819), a California appeals court held that “[A] provision in a contract that appears at first glance to be either a liquidated damages clause or an unenforceable penalty provision may instead merely be a provision that permissibly calls for alternative performance by the obligor.” Id. at 14. So, why is this decision important? It is important because it affects how existing contract provisions are likely to be interpreted going forward, and it affects how future contracts will be drafted.

To better understand the ramifications of the McGuire court’s holding, it is important to understand the term “liquidated damages.” The McGuire court defines liquidated damages “as an amount of compensation to be paid in the event of a breach of contract, the sum of which is fixed and certain by agreement, and which may not ordinarily be modified or altered when damages actually result from nonperformance of the contract.” Equating them with penalty clauses, courts have historically looked down on liquidated damages provisions in contracts and found them unenforceable; however, in the late 1970s, California changed this presumption of invalidity, replacing it with a policy of presumptive validity in commercial, non-consumer contracts. Currently, a liquidated damages clause is valid if the provision is signed or initialed by each party; set out in 10-point or 8-point bold type (depending on the ink color); and, reasonable under the circumstances that existed at the time the contract was made. If these requirements are not met, the clause will be found unenforceable.

A brief review of the facts of McGuire shows that in 2006, the plaintiff purchased two lots from the defendant. Pursuant to the purchase agreements, defendant was required to ensure that the covenants, conditions, and restrictions in place on the lots be amended so that the owners of three nearby lots not be permitted to construct or install any structure within 900 feet of the access road adjoining the plaintiff’s property. If the defendant failed to do so, it would be required to refund the plaintiff $80,000. The defendant failed to perform, and the plaintiff sued for damages, including the $80,000 refund. The trial court ruled in favor of the defendant, finding that the provision was an unenforceable penalty on the ground that neither had performed any research to determine how much the plaintiff would be harmed by the failure to obtain the amendments. As quoted above, the appeals court reversed, holding that the provision was not a liquidated damages provision but, rather, an alternative performance provision.

The McGuire decision is a way for California attorneys to get around the formal requirements of liquidated damages, as discussed above, and it also seems to expand the acceptability of contract clauses that previously may have been considered penalty provisions. Before you or your company draft, enter into, or revise a contract, be sure to obtain the expertise of an experienced Sacramento business attorney. The Law Office of Kristina M. Reed can help. If you have questions about revising an existing contract, or need assistance drafting a contract or reviewing a proposed contract please contact us.