Contract Tip - Liquidated Damages
A liquidated damages clause is a provision in a contract that fixes a pre-negotiated amount of damages that will be due to one party if the other party breaches the contract. For example, if a home buyer gives the seller a $1000 deposit and later the home buyer decides not to purchase the seller’s house, the contract may state that the seller gets to keep the buyer's $1000 deposit as liquidated damages. A termination fee for canceling your cell phone contract early is another example of liquidated damages.
Liquidated damages will be enforced if:
1) the actual amount of damages is uncertain or difficult to estimate at the time the contract was formed, and
2) the amount of liquidated damages is a reasonable forecast of the actual damages that would be suffered.
A liquidated damages clause will NOT be enforceable if it is designed as a "penalty." For example, assume a school contracts with a construction company to build a new playground, and the contract states that if the playground is not completed by the deadline then the construction company will have to pay the school $1000 per day for each day the project is late. This will be an invalid liquidation clause because it is highly unlikely the school will lose $1000 per day due to the playground construction being late. This clause is not a reasonable forecast of damages, and it would therefore be viewed as a penalty. As a result, a court would not enforce this provision against the construction company.