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Liquidated damages. (Legal Jargon).(Brief Article)
As a credit professional, you deal with contracts every day. A common, but sometimes misunderstood, provision in contracts is a liquidated damages clause. If used properly, a liquidated damages clause can be a powerful tool. If the circumstances are not appropriate, a provision for liquidated damages can be a dangerous trap.
What are liquidated damages?
Liquidated damages are a predetermined amount of money that the parties to a contract agree will be awarded to one or both parties if there is a breach of contract. The amount of the liquidated damages represents the parties' estimate of the loss that will occur if the contract is breached. By their nature, liquidated damages are a fixed sum. They may be either a total fixed amount, or a fixed amount in relation to some other measure, such as a fixed per-day charge for delay in performance of a contract. Liquidated damages are frequently used in construction contracts and contracts for the sale of goods. More recently, liquidated damages provisions are appearing in contracts covering a wide variety of goods and services.
What are the advantages and disadvantages of liquidated damages?
A liquidated damages provision can be a useful tool, as it saves a great deal of time and money by eliminating the need to prove the actual amount of loss if a dispute or lawsuit arises. In addition, because the amount of damages is known ahead of time, the parties' "risks" in the transaction are more firmly established. The major downside to a liquidated damages clause is that it may turn out to be grossly disproportionate to the actual damage incurred by a party--either too small or too large. Ordinarily, if a court enforces the liquidated damages clause, a party will not have any other type or measure of damages available.
Are liquidated damages clauses enforceable?
Historically, liquidated damages provisions were not favored under the law and frequently not enforced. The courts considered liquidated damages provisions to be penalty clauses, and for this reason did not enforce the provision.
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