Liquidated damages are the amount of monetary damages that contracting parties agree will be paid by the breaching party if the contract is breached. This amount is written into the contract in a portion known as a liquidated damages clause. A liquidated damages clause sounds like it can be a penalty for a breach of contract, but it is not intended to be. A penalty is meant to be a punishment in case of a breach. On the other hand, liquidated damages are intended to serve as a protection for both parties who have entered the contract in case there was some type of breach.
Liquidated damages are allowed in a contract only if:
- The injury or amount of damages is uncertain
- The amount of liquidated damages is reasonable and is considered as anticipated harm
- The loss of amount of damages is hard to prove
- There is no other remedy to cover the damages
- The damages are served as a protection rather than a penalty
Liquidated damages clauses are not allowed if:
- The damages being requested are for an unconscionable amount (for example, if the liquidated damages stated are disproportionate to the loss, or if the sum greatly exceeds a reasonable estimate of the actual damages)
- The liquidated damages are intended to punish a breaching party rather than compensate the non-breaching party for losses
- The default was simply a mere delay in payment
Even if the contract allows for liquidated damages, the parties to the contract need to ensure that the clause follows the various requirements under contract laws. As with any contract clause or agreement, liquidated damages clauses should be drafted and reviewed by a competent contracts lawyer who is familiar with the rules in the area.
Courts will often enforce liquidated damages clauses if the damages for breach of the contract will be difficult to estimate. However, a court will not enforce a liquidated damages clause if the clause is unfair or awards an excessive amount of money. Likewise, a court will not award liquidated damages if the contract is based on fraud or mistake. If a court determines that such a clause is unenforceable, the clause is void, and the non-breaching party may sue for other contract remedies.
Basically, anytime damages are hard to anticipate and it is impossible to calculate how much a breached contract would cost, the parties would agree to set a fixed amount of damages in the contract so if one party does in fact breach the contract, the other party can collect that amount of damages previously agreed upon. The court will generally enforce the liquidated damages clause if the amount is reasonable and the damages are actually hard to prove.
- Reasonable down payments
- Reasonable proportions of the entire contract price (such as 10%)
- Damages that appear to be fairly calculated by the parties
- Uncertain amount of late fees if there was a delay
If you are drafting a contract, a business lawyer will help guide you through the complicated legal process so that you will be able to protect your legal rights. In the event that your contract has been breached, an attorney can help you get the remedy you deserve, and/or help protect you from unfair contract language.