Liquidated damages are predetermined amounts of compensation outlined in contracts to address the possibility of a breach on the part of one of the parties to the agreement. They are meant to pay for the losses that would result from the breach in a way that is simple, straightforward, and certain while also eliminating the need for arguments and litigation.

Liquidated damages clauses are frequently found in contracts surrounding construction projects, though they are also common in service and commercial contracts where breaches might lead to delays or have other predictable financial impacts. A significant amount of thought and research goes into identifying an amount that feels fair and appropriate to both sides. Both parties to the contract must be thoughtful and honest in anticipating what harm would be likely from a breach. Calculating what these actual damages would be requires considering project timelines, operational costs, market impact, and anticipated revenue losses. Though it is tempting to be punitive in this calculation, the liquidated damages included in a contract should be a reasonable prediction of costs that would be incurred.

One of the keys to including liquidated damages provisions in a contract is ensuring that it will be enforceable, and that requires a reasonable forecast of harm and proportionality. The amount that is promised must reflect a good faith estimate. If it is viewed as being either punitive or an amount that falls too far below actual damages, there’s a good chance that a court will invalidate the contract and refuse to enforce the terms. Similarly, the terms must be clear and unambiguous to make sure that disputes are avoided.

It’s important to remember that even when contracts include terms outlining liquidated damages, a breach may still require both parties to work to minimize actual losses. If a court perceives a failure to do so, they may reduce the damages that the harmed party can recover. It’s also important to note that changes in market conditions or project specifics can create significant changes between the predetermined liquidated damages amount and actual harm. In these circumstances, disputes may still arise.

Liquidated damages can be a potent risk management tool, but to make sure that contracts that include these clauses are enforceable and fair, you need to be meticulous in your calculations. To optimize their effectiveness, contact our experienced attorneys.