This resource addresses a common question for business owners: “Do I need a Liquidated Damages Clause in my Contracts?”.
It is essential that businesses look out for themselves in any contractual relationship, especially when and if the business relationship begins to deteroriate. In doing so, businesses often include certain clauses in the contract that will give them a soft landing if the other contracting party fails to perform their obligations, in order to mitigate their losses.
One of these provisions is the liquidated damages clause, which you would often come across in construction contracts. However, regardless of the context in the agreement, there are several reasons why you would a liquidated damages clause.
This resource will help you better understand why your business might need a liquidated damages clause. But first, what are “liquidated damages”?
What Is A Liquidated Damages Clause?
Let’s assume a company A&Co. has contracted ABC Engineering to manage the construction of a property development project. The contract stipulates and the parties agree that:
- the project must be completed within 6 months, and failure to meet the deadline will constitute a breach of the contract; and
- if ABC Engineering fails to complete the project in 6 months, they must pay A&Co. $10,000 for every week the project remains uncompleted.
Here,
- the weekly $10,000 payment is a “Liquidated Damages” fee/payment; and
- the specific provision of the contract that stipulates the $10,000 payment is the liquidated damage clause.
Therefore, it can be understood that Liquidated damages in a contract pertain to an ascertainable value of damages paid by a breaching party to the other party as specified in the contract’s provisions.
In other words, It is a type of damages based on the agreement of both parties and is usually guided by an estimation of loss that could be suffered as a result of an eventual breach of the contract terms.
Drafting A Liquidated Damages Clause
Generally, a liquidated damages clause structure depends largely on the nature of the transaction and business relationship. If you decide to include a liquidated damages clause in your contract, here are a few guidelines to consider.
- The clause should state how the pre-estimated loss was calculated and what assumptions were relied on.
- When calculating the liquidated damages to be paid in the event of a breach of the contract, there are certain costs you need to consider. These include staff, insurance, incidental expenses, administrative fees, litigation costs, etc.
- The clause should clearly define the circumstances of a breach that would automatically require payment of liquidated damages by the breaching party.
- The clause should specify a reasonable date upon which the contract should be completed. This would serve as a benchmark to determine the fundamental breach of the contract.
- Avoid unreasonable penalties. If you include unreasonable or non-proportional penalty amounts, your liquidated damages clause can be unenforceable.
- Above all, the clause should be clear, unambiguous, and easily understood by a reasonable person considering the contract’s language, circumstances, objective and purpose.
How Can You Enforce A Liquidated Damages Clause?
There are two reasons liquidated damages might not be enforceable.
First, whilst you may assume damage to be liquidated damage, the Court might determine it to be unliquidated damage.
The second is if liquidated damages are NOT outlined and agreed on before the parties exchange the contract.
Note that unliquidated damages are only determined after the parties have executed the contract and action for the breach has been brought to the Court.
A liquidated damages clause is only enforceable in the Court of law. When enforcing a liquidated damages clause, the Court considers if:
- the liquidated sum out of all proportion the worst possible loss resulting from a breach;
- the liquidated sum outrageous or unreasonable;
- the liquidated sum a fair price for all kinds of breaches ranging from minor breaches to serious breaches; and
- the liquidated sum will affect the breaching business so significantly as to cause severe loss or damage.
Having found reasonable arguments to the above questions, the Court can then enforce the liquidated damages clause in your contract.
Why You Need A Liquidated Damages Clause In Your Contract
Esesntially, a liquidated Damages Clause adds a level of assurance to the contract and your business.
At times, it is difficult to ascertain the kind of loss resulting from a breach of contract, which invariably affects how to compensate for the loss. This is why you need to include a liquidated damages clause in your contract to specify an estimated value that would suffice as adequate compensation for whatever kind of loss you may suffer from a breach of the contract.
Also, by including a liquidated damages clause in your contract, you can mitigate the need for dispute resolution or litigation over the damages incurred. In this way, the breaching party will have fewer grounds to contest the value of damages in Court, given that it was based on their voluntary agreement.
Further, a liquidated damages clause may help you avoid having to justify the amounts you’re claiming when enforcing the clause.
Takeaway
The importance of a liquidated damages clause in your contract cannot be overlooked. It is a proven way to incentivise your contractors to adhere to the terms of the contract and is instrumental in minimising the chances of disputes later on.
However, drafting the right clause is important to maximise the chances of the Court enforcing it.
Should you need help drafting or enforcing a liquidated damages clause, get in touch. At Lazarus Legal, we have a team of trusted lawyers ready to help you with drafting contracts as well as other legal requirements.
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Mark Lazarus
Mark Lazarus, the visionary behind the business and the fresh blood of the Lazarus Legal team, Mark (or Laz as he is often known) owes much of his success to his past experiences. And he’s made it his personal goal to bring that wisdom and formula to the firm.
