Contract Drafting: Liquidated Damages Clauses

All contracts are susceptible to breach and could eventually result in a costly, time-consuming contract dispute. In the event of a contract breach, the parties to the contract will most likely require the services of legal counsel to hammer out an acceptable resolution. Between the attorneys’ fees, court fees, and other associated legal costs, these kinds of disputes can end up costing a fortune. For this reason, the parties to a contract often wish to employ other methods of dispute resolution, such as an obligation to submit to arbitration or the inclusion of specific damages clauses. The liquidated damages clause is one of the most commonly used contract provisions, as it eliminates the need to figure out the nature and extent of the breach and the amount owed to make the aggrieved party whole. Here is a rundown on the liquidated damages clause:

Reasons for the Clause

In many cases, it is quite difficult to calculate the actual damages associated with a contract breach. A lot of factors influence whether and to what extent a breach negatively impacts a party, so coming up with a figure after the fact can be quite tricky. Plus, if there is not a specific damages clause included in the contract, then the party responsible for making the damages assessment will most likely be a judge. As a result, parties who wish to utilize the liquidated damages clause should clarify their intention to do so and the reasons for it. More than likely, it will suffice to say that calculating damages would be too difficult or time-consuming and/or that the effect of any breach is too uncertain at the time the contract is being drafted.

Actions that Trigger the Clause

In addition to indicating the intention to rely on a liquidated damages clause, the parties must identify and specify the actions which constitute a breach such that the clause is triggered. This particular aspect of the clause should be as detailed as possible. There are obviously a lot of potential scenarios for a contract breach, so it must be abundantly clear which actions will result in the payment of liquidated damages. Granted, some breaches may not be readily foreseeable at the time that the contract is drafted, so it is important to address unforeseen issues as well and clarify whether they may also trigger the clause.

Amount of Damages

For the most part, the parties to a contract will endeavor to come up with a specific amount of liquidated damages that will be owed. This amount has to be reasonable in light of the circumstances, and the amount imposed will generally be a fair estimate of actual damages associated with the specified breaches. If the parties decide on a specific dollar amount, this should be clearly written numerically and spelled out to ensure accuracy and clarity. In the event that the parties do not wish to establish a specific amount, they may instead include the precise formula to be used to determine the liquidated damages at the time the breach occurs.

Other Remedies

When a contract includes a liquidated damages clause that is triggered when certain types of breach occur, the payment of those damages is usually the only remedy available to the affected party. It would likely be unfair for there to be other consequences or remedies, as that is usually the point of negotiating the clause in the first place. However, to avoid ambiguity or further dispute, it is wise to incorporate language explaining that the liquidated damages clause is the exclusive remedy. Of course, if that is not the case, then that should probably be discussed and clearly laid out within the contract as well.

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