Liquidated damages: Overview, definition and example
What are liquidated damages?
Liquidated damages are a pre-agreed amount of money that one party must pay the other if they breach the contract. They’re designed to compensate the non-breaching party for specific losses that might be difficult to calculate after a breach. Instead of figuring out damages later, both parties agree upfront on a reasonable estimate of what a breach would cost.
For example, a construction contract might specify that the contractor must pay $1,000 for every day the project is delayed beyond the deadline.
Why are liquidated damages important?
Liquidated damages are important because they bring clarity and predictability to contracts. For the non-breaching party, they provide a straightforward way to recover losses without needing a lengthy legal battle to prove the exact damages. For the breaching party, they limit their liability to a fixed amount, avoiding uncertain or excessive penalties.
These clauses also encourage compliance, as the financial consequences of a breach are clear from the outset. However, courts will typically enforce liquidated damages only if the amount is reasonable and not a penalty designed to punish the breaching party.
Understanding liquidated damages through an example
Imagine a software company contracts a developer to build a custom application by October 1. The contract includes a liquidated damages clause stating the developer must pay $500 for each day of delay. If the developer delivers the app 10 days late, they owe $5,000 in liquidated damages. This compensates the software company for lost time and potential revenue caused by the delay.
In another case, a hotel chain agrees to lease a conference center for an event, but the hotel cancels at the last minute. The lease includes a liquidated damages clause requiring the hotel to pay the lessee $20,000 for the inconvenience and lost opportunities.
An example of a liquidated damages clause
Here’s how a liquidated damages clause might look in a contract:
“In the event that the Contractor fails to complete the project by the agreed deadline of June 30, the Contractor shall pay the Client liquidated damages of $1,000 per day for each day of delay, as compensation for losses incurred due to the delay. The parties agree that this amount is a fair and reasonable estimate of the actual damages likely to be suffered.”
Conclusion
Liquidated damages provide a practical way to address breaches by setting clear, pre-determined consequences. They save time, reduce disputes, and offer a balanced approach to compensating for losses without resorting to litigation.
By including well-drafted liquidated damages clauses in contracts, businesses can protect themselves from uncertainty, encourage compliance, and maintain fair and enforceable agreements. It’s a smart tool for managing risk in complex projects or transactions.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.