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Superior Court Enforces $48 Million Liquidated Damages Provision

Smart Sand Inc. v. US Well Servs. LLC, C.A. No. N19C-01-144 PRW CCLD (Del. Super. June 11, 2021)

A liquidated damages provision is enforceable under Delaware law if: (1) damages are uncertain at the time of contracting; and (2) the liquidated damages are reasonable. Courts will examine the parties’ intent at the time of contracting in determining whether a liquidated damages provision is enforceable.

Here, the defendant had entered into a contract to purchase sand. Under the contract, the defendant was required to pay a monthly non-refundable reservation charge regardless of the volume purchased, and to purchase two million tons of sand over a four-to-seven-year period at a variable price. If the defendant failed to purchase a certain minimum tonnage per year, it was required to make a true-up payment at a price of $40 per ton for the shortfall. At the end of the contract, the defendant was required to pay a cumulative true-up of $40 per ton for any tonnage short of two million tons, less any prior payments. Three years into the agreement, defendant ceased making purchases and meeting its payment obligations. Months later, it purported to terminate the contract. The plaintiff sent a final invoice indicating that the defendant had purchased over 793,000 tons of sand, resulting in a contractual shortfall of nearly 1.21 million tons, and a required true-up payment of $48.3 million. The plaintiff sued for non-payment.

The defendant argued that the contract’s “take-or-pay” provision was not a valid liquidated damages provision, and instead, either allowed for alternative performance or constituted an unenforceable penalty. In this post-trial decision, the Court concluded that defendant had failed to sustain its burden to show that the liquidated damages provision was invalid. The Court reasoned that there is no specific contractual language required to define a liquidated damages provision. For the first prong of the liquidated damages legal test, the Court found that the contract itself had noted the uncertainty of sand prices and related prices in the energy market and, thus, that damages were uncertain at the time of contracting. For the second prong, the Court rejected the defendant’s interpretation that the provision actually required that the final shortfall payment be a summation both of the total shortfall and each year’s shortfall—which, in effect, would result in an unconscionable amount (over $100 million) due to double-counting. Accepting the plaintiff’s suggested interpretation of the liquidated damages provision, the Court held that the accrued shortfall payments during the life of the contract were not unconscionable. The Court found that the $40 per ton shortfall payment arose from an offer and acceptance among the parties at the time of contracting and therefore bore a rational relationship to the measure of damages the parties could have expected or estimated. Accordingly, the Court concluded that the liquidated damages provision was enforceable.

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