Liquidated Damages - In a nutshell
The parties to a contract may include a clause requiring the offending party to pay a defined amount of money to the innocent party in the event of a breach. Such pre-determined sums are known as “liquidated damages”. A simple example would be if A agrees with B that he will pay £50 to B for each day that he is late in making a delivery.
The appeal of such clauses is clear. Recovery of damages by an innocent party is easier and the consequences of a breach are clear from the outset, hopefully encouraging the parties to comply with their obligations.
However, liquidated damages clauses need to be used with care. The level of damages to be paid must not be set to act as a penalty to deter a party from breaching the contract. Instead, the amount to be paid must be a genuine pre-estimate of the loss the innocent party is likely to suffer as a result of the breach. If the purpose of the liquidated damages clause is to act as a deterrent then it is likely to be invalid on the grounds that it is a penalty clause.
In addition, if the intention is that the liquidated damages are the only amounts that the innocent party will be able to recover in respect of that breach then this needs to be expressly stated in the contract.
Posted on 11/22/2014 by Ortolan
