Liquidated damages, which can also be known as ascertained damages, are damages that are awarded in a lawsuit stemming from a breach of contract.

What Are Liquidated Damages?

When a contract is breached, a court case normally follows. If the court decides that the injured party deserves compensation, they will receive what's known as liquidated damages. Some contracts include provisions that require liquidated damages to be provided when the contract is breached. If liquidated damages are included a contract, the sum must be a reasonable amount, meaning it should not exceed expected losses for breach of contract. Liquidated damages that are unreasonably large cannot be enforced.

If parties want their agreement to be valid, the contract should be written in such a way that it would be hard to calculate actual damages, and the damages listed in the contract should be reasonable. Almost every contract that is entered into for the purpose of exchanging money or for guaranteeing performance will include a liquidated damages clause. With this cause in place, a contracted party that fails to perform their duties will be required to pay the other party a certain sum of money.

Liquidated damages differ from punitive and actual damages because they can only be awarded when there is a contract in place.

How Can Damages be Liquidated?

Damages can only be liquidated if the injury suffered by one of the parties is unclear or not easily quantifiable.

The amount of liquidated damage must be reasonable, and should be based on the following factors:

  • The harm, whether real or expected, caused by the breaching of the contract.
  • How hard it would be for the injured party to prove the loss.
  • The inability to find another remedy for the harm that has been suffered.

Liquidated damages cannot be structured as a penalty. If the damages could be considered a penalty, the provision will not be enforceable. During a lawsuit, if the defendant can prove that the purpose of the provision is punishment for breach of contract instead of paying for damages, then the court may decide that the liquidated damages cannot be executed.

Liquidated Damages vs. Penalties

The biggest differences between penalties and liquidated damages are the amount of money involved. In almost every case, the amount of a penalty will exceed the losses that have actually been suffered. Penalties are meant to punish one party for breach of contract, and can also be used to deter a breach.

When the obligations listed in a contract are not fulfilled, a penalty will be applied. This is common in construction contracts where the builder does not complete the project in the timeframe described in the contract. While liquidated damages are related to breach of contract, they are meant to make up for anticipated losses, and should not and cannot be used as punishment.

Liquidated damages will be calculated while the contract is being written, and they are designed to protect every party that agrees to the contract. The idea of mandating payments as damages instead of penalties was first developed in equity courts. The purpose of these damages was to stop people from entering into contracts that they could not fulfill or that could be considered unconscionable. You can find a full explanation of the differences between penalties and liquidated damages in the Uniform Commercial Code in section 2-718(1).

As mentioned, it is not possible to punish a breach of contract using liquidated damages. However, it is possible to include punishment for breaches of contract by inserting a penalty clause. This clause will specify an amount of money that a party will be penalized if certain terms of the contract are not upheld.

Genuine calculations must be used when using liquidated damages in a contract. When a court finds that the calculations used to determine damages were not genuine, no liquidation can occur.

Advantages of Liquidated Damages

Real estate contracts will almost always include a liquidated damages provision. If you are the buyer listed in a real estate contract, these provisions can help restrict your losses if you default on the contract. On the other hand, if you are the seller, you will be protected by these damages because you will receive a guaranteed amount of money if a default occurs.

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