What is liquidated damages

For example, liquidated damages provisions in preprinted consumer contracts, like car rental agreements and club memberships, are generally subject to higher scrutiny because of the disparity between the relative bargaining power and sophistication of the parties involved.

On the other hand, courts are less likely to invalidate a negotiated agreement between two attorneys. Assuming you get over the hurdles related to enforceability, liquidated damages clauses have certain benefits.

They establish some predictability and can act as a type of insurance against the cost of a breach. Both parties have the advantage of being able to weigh the cost of performance against the cost of breach. In addition, the nondefaulting party never has to prove actual damages, which can be a time consuming and difficult task. Done properly, deciding on damages at the outset gives both parties the opportunity to settle on an amount that they think is fair instead of leaving this decision to the courts.

Besides the uncertainty of litigation, it is also time-consuming and costly. As discussed above, liquidated damages provisions are enforceable only if the damages are difficult to estimate, which makes it challenging to set an amount in the contract.

Each party should make an effort to provide a rough estimate of how much money a breach would cost their business and negotiate an amount that is fair to both parties. If your contract concerns a long-term project, such as a construction contract, consider a liquidation provision that sets a fee for each day the completion of a project is past due. Be sure that the amounts you select are reasonable and not punitive. The information provided on this site is not legal advice, does not constitute a lawyer referral service, and no attorney-client or confidential relationship is or will be formed by use of the site.

The attorney listings on this site are paid attorney advertising. In some states, the information on this website may be considered a lawyer referral service. Please reference the Terms of Use and the Supplemental Terms for specific information related to your state. However, there have been times where unscrupulous contract drafters have attempted to draft liquidated damage clauses in a way which constitutes a penalty, therefore, such clauses will not be enforceable.

In some cases, the liquidated damage provisions are often only given a cursory glance at the formation of a contract as this is the point where, typically, the relationship between both parties is at its strongest and the thought of failing to meet a date in the contract is not considered.

However, it is at this stage which offers the greatest chance for both parties to review and discuss the implications of the provisions. Generally, it is only when difficulties arise further down the line that a proper review of the liquidated damage clause is undertaken by the party liable to pay liquidated damages. What are liquidated damages?

Liquidated damages also referred to as liquidated and ascertained damages are predetermined damages that are typically agreed between the parties to a contract. Typically, these damages are to be paid upon a specific breach of the contract, for example, late performance. There are other damages that can be considered as part of a contract between parties, known as general damages or unliquidated damages. This is considerably more difficult to prove than to have a predetermined damage such as a liquidated damage, where these damages are agreed prior to the execution of the contract.

Can liquidated damages be claimed despite the other party not incurring any loss? In short, yes. It does not matter if the loss suffered is smaller or larger than the sum of the liquidated damage and importantly, the claiming party does not have to prove the actual loss. The longer answer is, it depends on the construction of the liquidated damage clause, and the circumstances in which the liquidated damage is being claimed.

For a liquidated damage clause to be enforceable, and for it not to be considered as a penalty clause, the liquidated damage must be a genuine pre-estimate of loss. Therefore, the clause must not intend to penalise, but rather to compensate in the event of a breach. Glossary terms: Jump to letter. Harassment Heads of Terms Holding Company. Quarter Day. Zero Hours. Popular documents Defects liability period and rectification of defects Defects liability period and rectification of defectsIt is common in construction projects for defects to manifest or appear in the works.

Interim injunctions—the American Cyanamid guidelines Interim injunctions—the American Cyanamid guidelinesThis Practice Note is concerned with substantive interim injunctions, which are a particular species of injunction granted on a temporary basis ahead of trial.

However, in Makdessi , the Supreme Court pointed out that context can sometimes be relevant and, in particular, in a "negotiated contract between properly advised parties of comparable bargaining power, the strong initial presumption must be that the parties themselves are the best judges of what is legitimate in a provision dealing with the consequences of breach". Comment : These decisions show the flexibility of LD clauses as a potential remedy in many commercial contexts.

Although the rule against penalties remains the biggest risk to the enforceability of these clauses, lawyers can be reassured by the courts' continuing reluctance to intervene in contractual relationships between experienced commercial parties unless absolutely necessary.

The focus on "legitimate interest" is worth bearing in mind, however, and it may be sensible to identify this in the contract itself. In fact, in Makdessi , the contract expressly recognised that the restrictive covenants in question had been included specifically to protect the extremely valuable goodwill in the business being sold. It is also worth noting the courts' increasing awareness of the commercial background and justification underlying LD clauses and the context in which they were agreed and it may be sensible for parties to keep written notes of the background and reasons for choosing the sums they did.

We bring together lawyers of the highest calibre with the technical knowledge, industry experience and regional know-how to provide the incisive advice our clients need. Sign up to receive the latest legal developments, insights and news from Ashurst. By signing up, you agree to receive commercial messages from us.

You may unsubscribe at any time. The information provided is not intended to be a comprehensive review of all developments in the law and practice, or to cover all aspects of those referred to. Readers should take legal advice before applying it to specific issues or transactions. We use cookies to improve your experience on our website.

By continuing to use our website, we understand that you are happy for us to do this. For more information on how we use cookies, or how to change your browser settings, please see our Cookie Policy. A virtual library of regularly posted insights and legal updates based on your selected preferences. Legal Updates. The PDF server is offline. Please try after sometime. This guide explains the critical steps to take in making sure liquidated damages clauses are enforceable.

Liquidated damages clause Including a liquidated damages LD clause in a commercial contract is a popular way of dealing with the possibility of breach. LD clauses: a practical remedy with numerous advantages LD clauses have much to recommend them in the commercial context.

Identifying a genuine LD clause As mentioned above, the essence of a liquidated damages clause is that the sum which the breaching party must pay on a breach is fixed in advance and written into the contract.

Distinguish the following: Indemnities: Commercial contracts often provide for the breaching party to indemnify the non-breaching party in respect of any loss it suffers as a result of the breach. However, unlike a true liquidated damages clause, the sum payable is not known until the breach has occurred and the loss has crystallised.

Clauses where the sum payable in respect of the breach is fixed by a third party: Again, these are not true LD clauses because the sum is determined by an external factor, and after the breach, rather than being specified in the contract. Incentive payments: Some contracts provide for the contract sum to increase if the supplier meets certain milestones ahead of time.

Although this is often a very effective way of securing performance, the payment increase is not triggered by breach and such a clause therefore operates in the opposite way to a genuine LD clause. Typical uses of LD clauses Situations in which LDs often appear include: Construction contracts: These typically provide that, if completion is delayed by reason of the contractor's breach, the contractor will be liable to pay the employer a specified sum for each day, week or month during which the delay continues.

IT development contracts: The mechanism works in a similar way to that described above with payments triggered by delays in completion.

Outsourcing contracts: In this context, LDs often take the form of service credits which apply to reduce the sums payable if services are not performed to the required standard. Employment contracts: Two examples of LD clauses in employment contracts have come before the courts in recent years 1. In one, it is worth noting that the judge commented that, although it was unusual to find them in this type of contract, there is no reason why they should not be used.

The penalty trap and the risk of unenforceability The considerable advantages of LD clauses will be lost if the clause is not legally enforceable. What makes a contractual provision penal?