A liquidated damages example would be a contractor that failed to complete a construction project on time and is charged daily until the project has been finished.

Basics of Liquidated Damages

Liquidated damages are a type of monetary compensation that is provided to an injured party when a contract has been breached. Contracts include liquidated damages in order to cover losses that result from a contract being broken. The amount of the damages will be listed specifically in the contract in most cases, although this is not a strict requirement. If no amount is listed in the contract, the court will decide what level of damages to award.

While liquidated damages can be used in most types of contracts, they are most commonly found in real estate contracts. The reason these damages are used for real estate is that calculating exact losses can be very difficult with these contracts.

Both parties listed in a contract can be protected by liquidated damages, although it may not seem that way at first glance. For example, one party will know the exact amount of money that they will be required to pay if they break the contract and the party that receives the damages will be able to recover their losses without the need to file a costly lawsuit. However, it's important that these damages are not being used to punish the breaching party, as this would make them invalid.

Clauses for Liquidated Damages

The liquidated damages clause should be used to define the precise amount of money that will be provided to the party that is harmed by a broken contract.

While these clauses are mostly beneficial, the drawback is that they may not be enforceable depending on how they were written. For example, if the amount listed in the clause is unreasonably high, meaning it doesn't reflect actual losses, courts will refuse to impose the damages. The reason for this is that the damages are acting as a penalty instead of being compensatory. For a liquidated damages clause to be enforced, it must fulfill two requirements. Should the clause fail to meet these criteria, or if there is no clause in place, courts will reserve the right to determine the amount of damages.

When courts are trying to decide if the liquidated damages are reasonable, courts will examine the circumstances when the contract was written as opposed to the circumstances when the breach occurred. If it is decided that the estimated losses were not reasonable, the damages won't be enforced.

Liquidated Damages Benefits

Predictability is the biggest advantage of a liquidated damages clause. One property knows that they will be shielded from losses if the contract is broken. Liquidated damages also allow for each party to calculate the value that they can receive from fulfilling their duties versus the losses they would incur from breaching the contract.

Another benefit is that the injured party would not need to prove actual damages like they would during a lawsuit. The parties can negotiate damages until an amount is decided that both believe is fair.

Definitions that You Should Know

For those inexperienced with contracts and liquidated damages clauses, it's important to define a few of the most basic terms that you may encounter when negotiating a contract.

One of the most important terms to understand is actual damages. These damages are monetary compensation awarded when someone suffers a loss. These losses can be in the form of money or property. Actual damages are also commonly referred to as compensatory damages. To receive actual damages, you, the plaintiff in a lawsuit will need to prove that you have suffered a:

  • Loss.
  • Injury.
  • Harm.

It's also important that you understand what a contract is and how it functions. At its essences, a contract is an agreement between two parties. Once this agreement is established, the parties will be legally bound. Usually, contracts are entered into for the purpose of exchanging a good or service for something of value, usually money. For example, you might agree to pay a contractor a certain amount for them to build you a home.

When the parties in a contract have a dispute, it will often end in a court case. The ultimate decision in a court case is known as a summary judgment. These judgments are often issued without a full trial taking place.

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