What are Liquidated Damages?

Liquidated damages are damages which are paid out in the event of a breach of contract. The damages are intended to provide fair compensation for the losses incurred as a result of the breach. They are not penal or punitive, and in fact, a liquidated damages clause in a contract will be considered void if it appears to be intended as a form of punishment for committing the breach. The purpose of these damages is to have a clear way to compensate people when another party to a contract fails to execute his or her part of the agreement.

Some contracts specifically include a liquidated damages clause which spells out the damages to be paid in the event of a breach. In other cases, the amount of damages is left unclear, or liquidated damages are awarded by a court when one party to a contract sues another for breach of contract. It is often advisable to agree upon these damages when establishing a contract so that in the event of a conflict or problem, the amount of damages will already be determined.

Several characteristics must be present for damages to be considered liquidated damages. The first is that the damages must be fair. If the amount appears excessive, given the actual harm incurred, it may be considered a penalty clause. Another important characteristic is that the damages themselves must be uncertain. If, for example, a contractor breaks a tool belonging to a client, the damage is certain: The contractor is liable for the value of the tool. On the other hand, if the contractor runs over schedule on the job, the damages are unclear, because it's not immediately clear how much monetary damage is experienced when overruns occur.

Liquidated damages for non performance can be assessed whenever it is clear that a party to a contract failed to perform duties clearly spelled out in the contract. Because the amount can sometimes be nebulous, it is advisable to consult with a lawyer when drawing up the contract to make sure that any damages are appropriate, and to discuss any breach of contract with a lawyer as soon as possible to determine the best course of action.

When signing boilerplate contracts, people should be aware that the contract may contain a liquidated damages clause. They should familiarize themselves with the clause and with the situations in which it will be triggered. If they feel that the terms of the contract are unfair, they may want to consider requesting a revision of the contract.