Liquidated damages (LD) are similar to general damages awarded after a breach of contract. However, they are pre-estimated amounts agreed upon by both parties. Therefore it is a fixed amount or rate stipulated in the contract. This monetary compensation can only be claimed when there is a liquidated damages clause in the contract.
These clauses are used in many contracts; mostly in IT and construction contracts yet there are examples in other contracts. The primary function is to quantify the damages payable. To enforce this clause, it should not be seen as a penalty. Preventing a claimant from claiming a sum of money or another remedy which has no relation to the loss. In addition, these clauses often insert a rate e.g.” $0.00 per day for each day beyond the due date for practical completion.” Damages are calculated as a rate which indicates a pre-assessment or pre-estimation if completion was delayed.
Some of the advantages of these LD clauses are:
- Provides certainty to the parties
- Facilitates recovery of damages by avoiding the requirement of proving loss
- Simplifies the dispute resolution procedure
- May incentivise performance of the contract
What Constitutes a Penalty?
If the amount payable is considered to be excessive, unconscionable, unreasonable or disproportionate to the greatest loss that could conceivably be proved following a breach, it might be regarded by the court as a ‘penalty’ which will make the clause not enforceable. This does not mean that the aggrieved party loses the opportunity to seek damages at law altogether. The plaintiff will need to seek compensation and prove actual loss in the usual method.
To ensure that your LD clause is not in the form of a penalty you should seek advice from one of the contract lawyers available on LawPath’s directory.
Drafting LD Clauses
Parties are entitled to all remedies for breach when drafting contracts. In Australia, courts have recommended that parties are careful when deleting, amending or adding clauses to the construction of contracts. Parties should be clear and concise when indicating that LD provided under the contract is the sole remedy available for delays in completion unless there are other circumstances involved. Contacting a commercial lawyer before finalising any contract would be best practice.
LD clauses sometimes referred to as ‘agreed remedies or damages clauses’ are accepted by the Australian courts and have several advantages to their inclusion as mentioned earlier. The difference between a reasonable LD clause and an unenforceable penalty clause can be difficult even when the parties have entered with the best of intentions. Therefore it is always important to seek advice about the full ramifications and consequences of that agreement before agreeing to those terms.
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