Liquidated Damages

Definition

Liquidated damages refer to a specific amount of money that contracting parties agree upon during the formation of a contract, to be paid in the event of a breach of contract. This predetermined sum is intended to estimate the actual damages that would result from a breach, rather than requiring the non-breaching party to prove the exact amount of damages suffered.

5 Must Know Facts For Your Next Test

1. Liquidated damages clauses are enforceable if the amount is a reasonable estimate of the anticipated actual damages at the time the contract was formed, and not a penalty.
2. Courts will generally uphold liquidated damages clauses unless they are found to be unconscionable or against public policy.
3. The purpose of liquidated damages is to provide certainty, avoid disputes, and compensate the non-breaching party without the need to prove the exact amount of damages suffered.
4. Liquidated damages are distinct from a penalty clause, which imposes an excessive, disproportionate amount as punishment for breach.
5. The availability of liquidated damages does not preclude the non-breaching party from seeking other remedies, such as injunctive relief or specific performance, if appropriate.

Review Questions

• Explain the purpose and benefits of including a liquidated damages clause in a contract.
  • The purpose of a liquidated damages clause is to provide certainty and avoid disputes by pre-determining the amount of compensation the non-breaching party will receive in the event of a breach, without the need to prove the exact monetary loss. This benefits both parties by ensuring predictability, saving time and resources that would otherwise be spent litigating the actual damages. Additionally, liquidated damages can compensate the non-breaching party without having to meet the higher burden of proving the precise amount of harm suffered.
• Describe the key differences between a liquidated damages clause and a penalty clause in a contract.
  • The primary distinction between a liquidated damages clause and a penalty clause is that liquidated damages represent a reasonable estimate of the anticipated actual damages at the time the contract was formed, while a penalty clause imposes an unreasonably high, disproportionate amount as punishment for breach. Courts will generally uphold a liquidated damages clause as long as the amount is a fair approximation of the potential harm, but will strike down a penalty clause as unenforceable. Whereas liquidated damages aim to compensate the non-breaching party, a penalty clause is intended to deter breach through the threat of an excessive monetary sanction.
• Analyze the circumstances under which a court may refuse to enforce a liquidated damages clause in a contract.
  • Courts may refuse to enforce a liquidated damages clause if it is found to be unconscionable or against public policy. This can occur if the predetermined amount is grossly disproportionate to the actual or anticipated damages, effectively functioning as an unenforceable penalty. Additionally, if the circumstances at the time of the breach have changed significantly from when the contract was formed, such that the liquidated damages no longer represent a reasonable estimate of the harm, a court may deem the clause unenforceable. The party challenging the liquidated damages clause bears the burden of proving that it is unreasonable or unenforceable under the specific circumstances of the case.

Related terms

Actual Damages: The real, quantifiable monetary loss suffered by the non-breaching party as a result of the other party's breach of contract.

Penalty Clause: A contract provision that imposes an unreasonably high amount of damages, disproportionate to the actual harm suffered, as a punishment for breach.

Breach of Contract: The failure of a party to perform their obligations under the terms of a legally binding contract, giving the non-breaching party the right to seek remedies.