What Are Liquidated Damages and How Do They Work?

Liquidated damages are a regular feature of construction contracts. This blog explains what they are and why you should use them.

What are Liquidated Damages?

Liquidated damages in construction are a contractually agreed upon sum of money that one party to a contract must pay the other party if they breach the contract. This sum is intended to provide the non-breaching party with compensation for any losses or damages they incur as a result of the breach. In the case of construction contracts, they are most often used in the context of delays to completion of the works.

The use of liquidated damages allows parties to a contract to agree in advance on an appropriate amount of compensation for a breach, rather than leaving it up to a court to determine the appropriate level of damages at a later date. This can provide certainty and clarity for both parties and can help to avoid costly and time-consuming legal disputes.

What terms must be met for liquidated damages to be enforceable?

In order for liquidated damages to be enforceable, they must be a reasonable estimate of the actual damages that the non-breaching party is likely to incur as a result of the breach. This means that the amount of liquidate damages must be based on a good faith estimate of the likely damages, and must not be so excessive as to amount to penalty clauses.

If a court determines that the amount of liquidated damage is not a reasonable estimate of the actual damages, it may reduce the amount of ascertained damages awarded or may even refuse to enforce the provision for liquidated damages altogether. In such cases, the non-breaching party would be left to seek compensation for their losses through other legal means, such as by suing for actual damages.

What to consider when determining provisions for liquidated damages

There are a few key considerations that parties to a contract should keep in mind when determining whether to include a provision for liquidated damages. First, they should carefully consider the potential losses or damages that the non-breaching party is likely to incur as a result of a breach and should make a good faith effort to estimate those damages. This will help to ensure that the amount of liquidated damages is reasonable and enforceable.

Second, parties should be aware that the inclusion of a provision for liquidated damages may not always be appropriate. For example, if the potential losses or damages that the non-breaching party is likely to incur as a result of a breach are difficult to estimate, it may be better to leave the determination of damages to a court.

Are liquidated damages beneficial?

In conclusion, a liquidated damages clause is a useful tool for parties to a contract to provide for a predetermined amount of compensation in the event of a breach. However, they should be used carefully, and only after careful consideration of the potential losses or damages that the non-breaching party is likely to incur.