Legalities 40: Should you include “liquidated damages” in your client contracts?

What are liquidated damages?

“Liquidated damages” set a specified amount of money to be paid if your client breaches your contract. While liquidated damages clauses are often found in graphic artists’ contracts, they may cause more problems than they solve.

If you are a freelance photographer, illustrator or designer, in your contracts or invoices you may be giving your clients limited usage rights to your work product (or license), instead of a full buy-out. (See Legalities 1 for a discussion of limited usage licenses vs. full buy-out of all rights.) Essentially, this means you are retaining copyright in the work, and, depending upon the rights you are granting to your client, you may be retaining rights to relicense the work to other clients, repurpose it for yourself, or even to charge the same client additional fees for usage outside the scope of the initial license.

Unfortunately, clients often do not understand that they are getting a limited usage license, instead they think they can use your work however they want to. It is common for clients to use work product beyond the scope of the original license without contacting the designer for permission to do so. To deal with this problem, freelance contracts may include a liquidated damages provision that says the client will pay a certain fee –  a flat fee or a multiple of the original fee – for any use the client makes beyond the scope of the original license. I have seen liquidated damages for as little as $150 per unlicensed use or as large as $10,000 per unlicensed use, and in multiples of 3 times, 5 times, or even 15 times the original fee.

Why are liquidated damages problematic?

Not all contract clauses are legally enforceable. Liquidated damages clauses can be challenged in court, and efforts to get them invalidated are often successful. Legally, liquidated damages are valid only when it will be difficult to calculate actual damages (your monetary losses or the client’s profits) caused by a contract violation or “breach.” They cannot be used to impose a penalty or as a way to get punitive damages (to punish the wrongdoer). Contract provisions for liquidated damages may be invalidated even if your client agreed to them (e.g., even if your client signed your contract that include liquidated damages). This is because courts do not want to endorse unreasonable or exorbitant penalties.

If you have liquidated damages in your client contracts, you may be increasing the risk that you won’t be able to amicably resolve unlicensed usage issues with your client. If your liquidated damages seem reasonable to your client, your client may just pay them. But if your liquidated damages are quite high, for example, several multiples of your original license fee, your client is likely to resist. At best, your client may just refuse to pay; at worst, your client may escalate the dispute to litigation.

How do courts determine if liquidated damages are invalid? 

To determine whether a particular liquidated damages clause is invalid, courts will decide if the amount is reasonable, and if both parties would have considered them reasonable at the time they made their contract. Courts ask questions like (1) does the amount of liquidated damages bear a reasonable relationship to the range of actual damages that the parties could have anticipated would result from the usage beyond the scope of the license? or (2) does the liquidated damages amount reflect the parties’ reasonable estimate of a fair average compensation for any loss to you from unlicensed use? If the answers are no, then the court will decide that the liquidated damages are an unenforceable penalty.

In this context, actual damages and fair average compensation would likely be measured as the license fees you would normally have charged for the unlicensed use, or the profits your client made from the unlicensed use, whichever is greater.

Liquidated damages will not be valid for pure copyright infringement

Depending on your specific contract language, sometimes your lawyer can characterize a client’s use of your work beyond the scope of the license as copyright infringement instead of just a breach of contract (a violation of any promise or obligation in a contract is a breach). This would not be a good strategy if you are trying to collect liquidated damages.

When a court interprets liquidated damages as payment for copyright infringement, it will likely find them invalid, even if the amount is relatively small. This is because copyright law says that the appropriate monetary remedies for infringement are your actual damages or the infringer’s profits. Penalties for copyright infringement are not allowed. Instead, copyright law provides the possibility of statutory damages, which can often be much more than actual damages or the infringer’s profits. (However, to be eligible for statutory damages, you must have registered the copyright in your work before the infringement occurred, or at least before you reasonably discovered it. See Legalities 39.)

If you want to include liquidated damages in your client contracts, it is important not to characterize them as payment for copyright infringement. If your contract language says your client will pay liquidated damages “for any copyright infringements,” obviously, that will be invalid. However, if you just say something like “for any unauthorized usage” or “unlicensed use,” that will also be invalid, because unauthorized use is by definition a violation of your copyright.

Liquidated damages might be valid for failure to include attribution, or other contract breaches

If your contract requires your clients to include credit or a copyright notice in your name when they use your work product, you can try including contract language that specifically ties liquidated damages to a breach of that attribution requirement. Failure to give attribution is not a copyright infringement, but it can be a breach of contract. So a court will look at whether the liquidated damages amount is reasonably proportionate to the monetary loss you would incur if credit is not given. In one case, a photographer’s contract set liquidated damages of $5,000 for each time credit for his photograph was omitted. The client had omitted credit from infomercials in which the photograph briefly appeared. At trial, the court ruled that the clause was invalid, because the photographer could not support the $5,000 amount, noting that there had been “no effort on either side to estimate the actual damages” that he would have suffered from the failure to include attribution. The court also noted that the $5,000 per omission purportedly applied regardless of any variables that would affect the value of the attribution, for example, whether credit was omitted from print or screen, or the size of the audience. In fact, the television infomercials had run late at night in small markets, and thus the court believed it was unlikely that the photographer had lost $5,000 in potential new business.

There are two lessons from this story: (1) specify in your contract an explanation for why you are including liquidated damages and why it may be impossible to calculate actual damages. For example, recite that credit is an important part of your compensation for the work because it has the potential to bring you new business, but the exact amount you would earn on such new business cannot be predicted; and (2) explain why the amount is a reasonable estimate of your actual damages. For example, on average, attribution on similar projects brings you X number of new freelance assignments, at an average of X dollars in fees. Such explicit statements in your contract give your clients the opportunity to challenge your liquidated damages amount when they review your contract before signing it. If they don’t do so, that could help establish that your client agreed the amount was reasonable. If your work product could be used in variable circumstances that would affect the value of the attribution, consider setting a tiered range of fees to approximate those different circumstances.

You can also use this strategy for other potential contract breaches, such as breach of a non-disclosure/confidentiality provision. Explicitly state in your contract that the liquidated damages are meant to compensate you for such a breach, and explain why the amount makes sense for such circumstances.

Liquidated damages are not a good idea if you want a secondary market for your work

Copyright law provides two types of remedies for unauthorized use: monetary damages and injunctive relief. Monetary damages are meant to compensate you for revenues you’ve lost (or your client has gained) from the infringement. Injunctive relief means the court will order the defendant to stop using your work. Even when you have established liability for copyright infringement, you are not necessarily automatically entitled to injunctive relief. Instead, the courts have to look at whether you will suffer “irreparable harm” if the infringement isn’t stopped. Arguably, by charging liquidated damages, you would be allowing your client to continue the unlicensed use. At least one court ruled that by including a liquidated damages clause (even if invalid) in his contract, the copyright owner indicated that he believed monetary damages were sufficient to remedy the harm caused by unlicensed use. The court refused to grant injunctive relief.

In some cases, the work you are creating for a particular client is so specific to that client that there really is no other use for it – for example, photographs, packaging or website design featuring a particular brand or product. In other cases, your work may be suited for a lucrative secondary market of relicensing – for example, photos or illustrations of generic subject matter, or preliminary alternative designs that are not chosen for implementation by your client. You will want to be able to stop your client from continuing to use these works so that you can exploit the secondary markets yourself. For such projects, liquidated damages should not be in your contract. You will need the right to injunctive relief to protect your secondary market. Make sure your contract recites that in case of a breach, you reserve rights to injunctive relief in addition to monetary damages.

Are there alternatives to liquidated damages?

Liquidated damages clauses in contracts should alert your clients to the legal reality that they are receiving only limited usage rights, and there will be consequences if they use your work beyond the scope of the license. However, as discussed above, enforcing liquidated damages is problematic. Here are some alternatives:

Full buy-out

When you start a new client project, think about whether any work product you create would be useful to you for repurposing for other projects. If not, consider whether it would make sense to offer the client a full buyout of all rights instead of a limited usage license. You will get a larger fee up front, and you won’t have to worry about policing your client’s usage. Your client will get unfettered rights to use the work without worrying about whether it will inadvertently misuse the work. Many clients assume they are getting a full buy-out anyway, even if they sign a limited usage agreement, so this approach also avoids disputes about that later.

Usage options in your project proposal

When you present a project proposal to the client, instead of just listing the usage you believe the client needs, give the client a checklist of different usage levels with associated fees. Include your fee for full buyout of unlimited usage rights as the final option. Have your client choose which usage option it wants (perhaps by simply checking or initialing a box next to the chosen option). This way, your client sees up front that there are different usage levels and different fees associated with each level. Your client will also see that by choosing a usage option instead of a full buyout, the client is not paying the full buyout price for unlimited usage. This makes it much harder for your client to argue later that it thought it was getting unlimited usage rights. You have also warned the client of the additional fees it will owe for the unlicensed usage.

Liquidated damages as a settlement offer

Another idea is to characterize your liquidated damages provision as settlement offer. Your contract can say that, in the case of a use outside the scope of the original license, you may opt to make a settlement offer by invoicing the client for a specific fee. If the client pays that fee within a certain time frame (say, 30 days), the client gets a new license to cover the new use for a certain period of time. If not, the settlement offer will be withdrawn, and you can pursue your normal legal claims for monetary damages and injunctive relief.

You can also include a second settlement option, stating that, depending upon the scope of the unlicensed use, you may invoice the client for a full buyout of the work, for your typical buyout fee (state the buyout fee right there in the contract). Copyright to the work will be signed over to the client upon receipt of the buyout fee within a certain time frame.

Prevailing party attorneys’ fees

When your client breaches your contract, you have to spend extra time and money (often, attorneys’ fees) to deal with it. Your actual damages and fair average compensation for the breach won’t cover those extra costs. If you have a copyright infringement claim, and you had already registered your copyrights before the breach, you might get statutory damages greater than your actual damages. But courts often look at what your actual damages would have been in setting the amount of statutory damages. And, even though your prior registration allows you to seek reimbursement of your attorneys’ fees, that is not automatic. The courts are getting stricter about awarding them.

Luckily, there is an easy way around this: always include a provision in your contracts that the prevailing party in any arbitrated or litigated dispute will be awarded its reasonable attorneys’ fees. Prevailing party attorneys’ fees clauses are valid and honored as a matter of contract law, whether or not you have a copyright claim or a prior copyright registration. If you get into a dispute with your client, your client will be less tempted to stonewall on your legitimate claim because your prevailing party attorneys’ fees clause means they will have to pay double attorneys’ fees (theirs and yours) if you are forced to litigate and you win. There is a much stronger incentive to resolve legitimate disputes when you have a prevailing party attorneys’ fees clause.

Conclusion

Liquidated damages can be helpful if, when you discover your client has used your work beyond the scope of the license, your client believes it’s better to just pay the liquidated damages amount rather than fight you. But if the amount is set too high, for example, at 10 times the original fee, your client is more likely to resist paying it. If the dispute escalates, your liquidated damages clause is likely to be he invalidated, and you may not get injunctive relief.

How to use liquidated damages wisely

If you decide to include liquidated damages in your client contract, try to avoid the legal pitfalls:

  1. Do not set liquidated damages amounts too high. Many multiples of your original license fees will more likely provoke your client to resist paying, and will be invalidated by the courts. Consider setting the amount at or under the legal limits for small claims court in your state. Small claims gives you an inexpensive process to enforce your rights, and small claims judges might enforce liquidated damages if they seem reasonable.
  1. Specify in the contract that the liquidated damages are for specific types of breaches, and don’t say they are for copyright infringement, or unauthorized or unlicensed use.
  1. Explain why you need liquidated damages and why the amount is reasonable in the contract.

Consider  alternatives

If you don’t need to repurpose the work, consider granting your client a full buyout up front. Or, provide for settlement options in your contract if your client uses the work later beyond the scope of the license. If you  need injunctive relief to preserve your secondary market, don’t provide alternatives that would allow your client to continue using the work indefinitely. Make sure your contract includes clauses that preserve your rights to injunctive relief for unlicensed use, and prevailing party attorneys’ fees.

 

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LegalitiesSM is a service mark. © 2020 Linda Joy Kattwinkel. The information in this column is provided to help you become familiar with legal issues that may affect graphic artists. Legal advice must be tailored to the specific circumstances of each case, and nothing provided here should be used as a substitute for advice of legal counsel. Linda Joy  is an attorney, painter and former graphic artist/illustrator. She practices intellectual property law, arts law and mediation for artists in San Francisco. She can be reached at 415-882-3200 or ljk@owe.com.