We’re sure you’ve spent many sleepless nights wondering about liquidated damages. Well, now you can banish insomnia for good. We take you through all the things you need to know about liquidated damages provisions in contracts and what to do if you come across one.
- Liquidated damages are a fixed sum payable to a party to compensate it for a specific breach or failure by another party. While typically found in the mystical realm of construction contracts, LD clauses are starting to appear in all sorts of commercial contracts including manufacturing agreements and those for the provision of goods and services.
- Liquidated damages are designed to compensate an injured party for a specific breach – not to penalise the defaulting party or deter it from breaching the contract. Liquidated damages need to be a “genuine preestimate of the loss” that is likely to be suffered by a party as a consequence of a breach. If it isn’t, then the obligation to pay that sum will be considered a "penalty" and be unenforceable. The sum of LDs needs to be properly calculated and well thought out – just because you say it’s a “genuine preestimate” doesn’t mean it is.
- Once the parties have agreed to the level of liquidated damages, the injured party only needs to show that a breach or failure has occurred for that agreed sum to be payable.
- Liquidated damages are particularly handy where services are time critical or interdependent with other things. Say you’ve contracted with a web developer to build your new e-store. You’ve booked tonnes of media to promote the launch. One consequence of the e-store not being delivered on time is the cost of cancelling all that media. You could include in the contract a specific amount to reimburse you for those costs if the project is late. That’s a liquidated damage. You might be late in finishing your project, but at least you won’t be out of pocket.
- The payment of liquidated damages doesn’t automatically prevent an injured party from making a claim for further damages. If you’re up for paying liquidated damages, make sure that these are the other party’s sole and exclusive remedy for that breach.