Liquidated DamagesFor when the amount of actual losses is hard to estimate

When someone breaches a contract and the other party suffers because of it, there might be a case where the other party has the right to receive money.

We refer to this monetary award as damages.

There can be different methods of calculating damages depending on the circumstances and the language of the contract.

Damages even have different categories: compensatory, punitive, liquidated, or nominal damages. 

Liquidated damages are the type of damages that are included in the contract itself.

They are there as a guideline for when a breach occurs.

The purpose of liquidated damages is to make it easier to determine the right monetary award when it’s otherwise difficult to estimate.

For example, a party in a contract leaks the supply chain pricing information which causes losses for the other party.

However, it’s hard to ascertain how much the monetary amount of losses is.

Having a liquidated damages clause in the contract addresses this difficulty in determining the monetary amount of losses.

In this article, we will be exploring what liquidated damages are.

Are they always enforceable?

Up to what extent is the amount for liquidated damages appropriate?

Let’s find out.

What Are Liquidated Damages?

Liquidated damages refer to damages that are included in certain legal contracts.

They are there to act as an estimate of otherwise intangible or hard-to-define losses to one of the parties in the event of a breach of contract.

If there is a liquidated damages clause in a contract, a predetermined amount of money is specified.

This predetermined amount will serve as a guideline for how much the monetary award will be if one of the parties breaches the contract.

The amount will usually be both parties’ best estimate at the time of signing the contract.

Meaning that both parties should agree to the set amount.

If either of them breaches the contract, they no longer calculate the actual damages.

Instead, they will refer to the liquidated damages clause to determine the amount that the breaching party pays to the other party.

For example, it’s hard to ascertain the monetary amount of losses that arise from the leaking of trade secrets such as the design of a new product.

It’s hard to set an amount for a design, but you know that it has value.

If an employee or any other party leaks it, the business’s ability to generate revenue from the release of the new product will be greatly hampered.

Since it’s hard to ascertain the appropriate amount of losses before the actual release of the product, the business will have to include a liquidated damages clause in the contract.

The business then estimates how much the losses will be should such an event occur.

The business then includes the amount in the liquidated damages clause.

By nature, liquidated damages are not punitive.

Rather, they are fair.

They are there for situations where determining the appropriate amount of losses is difficult, bordering impossible

When is a Liquidated Damages Clause Enforceable?

For a liquidated damages clause to be enforceable, it should meet both of the following criteria:

It’s difficult or almost impossible to set an appropriate amount for potential losses

A liquidated damage clause is usually included in the contract when it’s hard to determine the monetary amount of losses.

As such, a court will more than likely enforce a liquidated damages clause if the monetary amount of actual damages is hard to estimate (at the time of signing the contract).

This is usually the case with intangibles where it’s hard to set a monetary value.

Always remember that for a liquidated damages clause to be enforceable, the amount of damages should either be uncertain or hard to estimate at the time of signing the contract.

The amount must be reasonable otherwise it becomes punitive

The amount set for liquidated damages must not be grossly disproportionate to the amount of actual damages.

If a court finds the amount of liquidated damages to be grossly disproportionate, it will consider the amount to be a penalty instead.

As such, it will most probably not enforce the liquidated damages clause.

This is to prevent the plaintiff from attempting to claim an unreasonable amount from a defendant.

For example, the amount of liquidated damages may be grossly disproportionate if it’s significantly greater than the plaintiff’s gross revenue at the time of signing the contract.

Benefits of a Liquidated Damages Clause

When executed properly, a liquidated damages clause can benefit both parties in the contract.

For one, such a clause can act as a type of insurance should there be a breach of contract.

It also establishes some sort of predictability because both parties will know how much the monetary amount of damages will be should either of them fail to honor the contract.

As it is an agreement between the two, both parties have a final say on what the amount should be.

This means that both parties must agree on what amount is fair. 

Additionally, a liquidated damages clause can potentially make the process of proving actual damages unnecessary.

This means that the non-defaulting property does not have to prove actual damage.

This is a benefit because proving actual damages can be a daunting and time-consuming task.

If done properly, either party will more than likely not have to go to court to enforce the clause.

Instead, they can settle between themselves.

Litigation can be time-consuming and costly after all.

Doing away with that is a huge plus.