Liquidated Damages

Liquidated damages

Key takeaways

• Liquidated damages (LDs) are a pre‑agreed sum in a contract payable if a party breaches the agreement and certain losses are hard to quantify.
• They are intended to compensate for anticipated, intangible, or difficult‑to‑measure harms — not to punish.
• Courts will enforce LD clauses only if the amount is a reasonable estimate of probable loss at the time the contract was made; excessive or punitive amounts may be rejected.

What are liquidated damages?

Liquidated damages are a contractual provision that fixes the amount one party must pay another if a specified breach occurs (for example, a missed deadline or disclosure of confidential information). They are used when actual damages would be uncertain, speculative, or difficult to calculate.

The clause should reflect a good‑faith estimate of likely harm when the contract is signed, so both parties understand the financial consequences of nonperformance.

How they work

• Parties negotiate and include a dollar amount (or formula) in the contract for certain breaches.
• If the triggering event occurs, the injured party can claim the liquidated amount instead of proving actual loss.
• The purpose is compensation and predictability, not punishment.

Examples

• Real estate: a buyer who backs out may forfeit a deposit specified in the contract.
• Commercial agreements: a supplier or consultant who leaks trade secrets or marketing plans may owe a predetermined amount to the hiring company.
• Construction: a contractor who fails to complete a project by a contractual date may pay a per‑day liquidated sum for delays.

Special considerations and enforceability

• Courts generally enforce LD clauses if they are a reasonable preestimate of probable loss at contract formation.
• Courts may void a clause that functions as a penalty — where the amount is grossly disproportionate to the expected harm.
• The reasonableness test looks at circumstances as they existed when the contract was made, not after the breach.
• A clear LD clause can simplify dispute resolution and provide leverage for settlement negotiations.

Important: Liquidated damages are compensatory, not punitive. If a court determines a clause is punitive, it may refuse enforcement and leave the injured party to pursue actual damages instead.

Liquidated vs. unliquidated damages

• Liquidated damages: amount is specified in the contract in advance.
• Unliquidated damages: amount is not predetermined; the injured party must prove actual loss and the court determines awardability.

Types of damages (legal context)

When a court awards damages, they generally fall into:
* Economic damages — quantifiable financial losses (lost profits, repair costs).
* Non‑economic damages — non‑monetary harms (pain, reputational loss).
* Punitive damages — intended to punish egregious misconduct (not typically relevant to commercial LD clauses).

Bottom line

Liquidated damages clauses provide certainty where losses are hard to measure, allocating risk between contracting parties. To be enforceable, the stipulated amount should be a reasonable estimate of anticipated harm at the time of contracting and not a disguised penalty. Include clear, well‑documented rationale for the amount in the contract to improve the clause’s enforceability.