Liquidated Damages Clauses: What You Should Know

In the past, you have likely entered into a contract that contained a liquidated damages clause. These are prevalent in construction and general commercial agreements.

Liquidated damages and penalty clauses

Liquidated damages (or stipulated damages) clauses are estimates made at the time the contract is formed of the expected losses a party will suffer in the event of a breach of the contract. Traditionally, these clauses are enforced as long as they represent a genuine attempt to pre-estimate the loss. ¹

Where such a clause is deemed not to be a genuine pre-estimate but is rather a sum that is "extravagant and unconscionable in amount in comparison with the greatest loss that could conceivably be proved to have followed from the breach," the clause will be considered an unenforceable "penalty clause."² These are clauses which are essentially designed to deter a party from breaking a contract, irrespective of the anticipated loss.