Liquidated Damages: What are they, how are they used and are they enforceable?

Liquidated damages is a specific sum of money agreed to by the parties to a contract as the amount of damages to be recovered in the event of a breach of the contract. A liquidated provision in a contract will be held enforceable if 1) the injury caused by the breach is difficult or impossible to determine; 2) the parties to the contract intended to provide for damages and not a penalty; and 3) the agreed upon liquidated damages is a reasonable pre-estimate of the probable loss.

The key issue in determining whether a liquidated damages provision is enforceable is to determine the intention of the parties to the contract as to whether the amount of liquidated damages was determined and fixed to satisfy the injury which would result from the violation triggering the liquidated damages provision or whether it was a penalty forced on a party to pay in the event of the breach. The intent of the parties to the entire contract is to be gathered and construed.

Even if the liquidated damages provision is construed as a penalty, it will be enforced if the amount is limited to the amount of damages actually shown, rather than a liquidation of the damages.  Therefore, liquidated damages provisions in contracts will be held unenforceable where the actual damages can be accurately determined and the amount of stipulated liquidated damages bears no reasonable relation to any probable actual damages.

Liquidated damages will be deemed the exclusive remedy in a contract where the parties have provided for that. A non-breaching party who agreed to accept liquidated damages as the remedy cannot elect to take actual damages even if they were greater.  Likewise, a breaching party cannot complain that the actual damages are less if they have agreed to liquidated damages as the exclusive remedy.

A liquidated damages provision typically found in construction contracts calls for damages in a certain amount for delay in completion of the project. This type of liquidated damages is typically enforced because it is difficult to determine the actual amount of damage caused by the delay. However, liquidated damages for delay will not be enforced if the actual damages can readily be calculated.

In summary, liquidate damages provisions will be enforced when the amount stipulated is a reasonable estimate of the actual damage that would be incurred. The court will look to the entire agreement to determine whether the damage stipulated is an estimate of damages or simply a penalty.