Liquidated DamagesCredit Repair Definition
A specific amount of money pre-agreed upon in a contract to be paid as compensation if a breach occurs.
Definition
Liquidated damages are a sum of money that parties to a contract agree upon in advance to serve as compensation for potential losses if a specific breach of contract occurs. This amount is written into the contract itself. The purpose is to pre-determine damages for breaches where calculating the actual damages would be difficult or uncertain at the time the contract is formed. For a liquidated damages clause to be enforceable, the amount specified must be a reasonable estimate of the actual damages likely to result from the breach and must not be intended as a penalty to punish the breaching party. If the amount is deemed excessive or punitive, courts may refuse to enforce it.
Frequently Asked Questions
When are liquidated damages clauses typically used?
They are common in contracts where actual damages from a breach are hard to predict, such as construction contracts (damages for project delays), real estate purchase agreements (buyer forfeits earnest money for backing out), employment contracts (non-compete violations), and software development agreements.
What makes a liquidated damages clause enforceable?
Courts generally enforce liquidated damages clauses if: (1) Actual damages were difficult or impossible to estimate accurately at the time the contract was made; and (2) The amount specified is a reasonable forecast of the harm caused by the breach, not an excessive penalty designed to deter breach rather than compensate for loss.
How are liquidated damages different from a penalty clause?
Liquidated damages are intended as a reasonable pre-estimate of actual losses. A penalty clause is designed primarily to punish the breaching party or coerce performance, often setting an amount disproportionately high compared to potential actual damages. Courts generally refuse to enforce penalty clauses.
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