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Liquidated Damages Clauses in Contracts

January 15, 2015

As a business owner or manager, you deal with a variety of contracts on a daily basis. With so many different types of clauses and terminology, contracts can easily become complicated and cumbersome. Even if you use a legal professional to help draft and review contracts, you still need to personally understand what your contractual obligations are, since your business will ultimately be held responsible.

Liquidated damages (LDs) clauses are a popular and practical way to deal with the possibility of contract breaches between businesses. LDs clauses are common in many different types of contracts, including commercial construction and engineering contracts, sale or supply of goods contracts, IT development contracts and more. However, just inserting any sample LDs clause in a contract is not enough—businesses need to ensure that the clause is properly considered, accurately written and enforceable by the courts.

What are Liquidated Damages Clauses?

A LDs clause in commercial contracts establishes that if a party breaches a particular obligation under the contract, then they must pay a specified sum of money to the other party as compensation for that breach. The sum payable for the breach is fixed, agreed to by both parties and written into the contract.

There are several benefits to using LDs clauses in your contracts, including:

 

Make Sure Your Liquidated Damages Clause is Not a Penalty

While LDs clauses have many benefits, in order to utilise these benefits, you must make sure that your LDs clause is enforceable. While courts typically uphold provisions in commercial contracts that have been freely entered into by both parties with similar bargaining powers, they will likely not enforce any agreements that are considered a ‘penalty’ or punitive in nature. Therefore, as long as the court finds that your LDs clause is indeed a LDs clause and not a penalty clause, it will likely be enforceable.

The courts will look at several principles when determining whether a LDs clause is considered a penalty clause or not, including:

 

This list is not exhaustive and the court may look at additional factors and elements.

Hints and Tips for Drafting a Proper Liquidated Damages Clause

Consider the following tips when drafting your LDs clause to help ensure that it will not be considered a penalty.

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