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What is the liquidated damages clause?

A contractual provision requiring a party in breach to pay a pre-determined amount to the other party as compensation for the breaching party's failure to perform a specific task or comply with a particular duty or obligation.

What Are Examples of Liquidated Damages?

Here are some examples of liquidated damages:

Example 1: Liquidated damages for selling a product on late delivery

Suppose a business agrees to sell a product to another company but fails to deliver the product on time, the buyer is entitled to liquidated damages. It could be in the form of a percentage of the total cost of the product or a specific monetary amount.

Example 2: Liquidated damages for the failure to provide a service

Suppose a business agrees to provide a service to another company but fails to do so. The supplier is entitled to liquidated damages. It could be in the form of a percentage of the service's total cost or a specific monetary amount.

Example 3: Liquidated damages for late payment

Suppose you are late in making a payment. In that case, the liquidated damages clause may provide a specific amount of money owed by the late party. For example, suppose you are one day late on a payment of one thousand dollars. In that case, you may owe ten dollars extra as liquidated damages. Such a clause aims to be a deterrent against tardiness. It also provides some predictability in the event of a violation.

Example 4: Liquidated damages for copyright or trademark infringement

You can use liquidated damages in a construction contract to compensate for copyright or trademark infringement. For example, a contractor reproduces copyrighted material without the copyright holder's permission. As a result, the copyright holder may sue for damages. The parties may agree to a liquidated damages clause specifying a certain amount to avoid this situation.

Example 5: Liquidated damages clause in a lease agreement

An example of when the landlord may claim liquidated damages is failing to pay rent on time. If the tenant breaches the lease agreement, they may be liable to pay liquidated damages to the landlord. This clause sets out a particular amount of money that the tenant would have to pay in the event of a breach. It can help to avoid costly legal disputes between the two parties.

Example 6: Liquidated damages clause in a loan agreement

To ensure that the loan repayment process is smooth, the lender and the borrower agree to a liquidated damages clause. This clause specifies that in the event of a breach of contract by the borrower, they will be liable to pay a predetermined amount of money. The parties set the amount at a level meant to compensate the lender for the losses they would have suffered due to the breach.

Example 7: Liquidated damages clause in an employment contract

If an employee breaches the employment contract, the employer may recover liquidated damages. In most cases, the amount is equivalent to the employee's salary if they saw their duties through the end of the notice period. This liquidated damages clause is not a penalty but a measure of damages to compensate the employer for losses from the Employee's breach. It is beneficial to include a liquidated damages provision in a contract, but such a provision is not always enforceable by law. If the predetermined compensation is highly disproportionate to the actual loss or injury sustained, the court will declare the provision void because it seems more like a penalty than a proper estimate of actual damages.

If you can overcome the obstacles related to enforceability, you can expect to reap certain benefits from having a liquidated damages clause in your contract. Firstly, the clause establishes some predictability and provides protection from injury or loss resulting from a breach of contract. It enables both parties to a contract to compare the cost of performance with the cost of a breach.

Additionally, a liquidated damages clause does not require the non-defaulting party to perform the potentially difficult and time-consuming task of proving actual damages. When it is properly done, it allows both parties to agree on an amount of compensation that they think is fair rather than letting the court make the decision. Litigation can be an uncertain, costly, and time-consuming process.
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