This contract tip is about some basics about liquidated damages (LDs) in contracts governed by U.S. laws.
An LD provides for a specific fixed damage amount if a specific event occurs. We use these provisions to provide the party with a quick and predictable measure for a specific type of contract breach. They seem simple enough, but LD provisions are anything but simple.
The most common use of LDs is for delivery delays. If the vendor is late, the vendor has to pay a fixed amount per day or week of delay.
Courts are reluctant to enforce LDs. They tend to do so only when narrowly drafted and including all the bells and whistles. To make sure they are enforced, every LD should have these five elements:
1. A specific breach that triggers the LD,
2. A precise measurement of the cost unit for the LD,
3. A precise measurement of time to which the cost applies,
4. Recitation of the fact that it is not a penalty,
5. Recitation that the amount of damages would be difficult to determine, the amount is a reasonable estimate, and it is the sole remedy and liability for this breach.
Vendors often ask for a grace period before the LD applies and a cap on the amount. Customers should try to limit the breach period or scope so they have a remedy if it goes on longer. For example, the LD is the sole remedy for a delay of up to 30 days, but any longer is a material default with a different remedy.
I usually see LDs used with equipment and construction-related contracts. I don't see them used very often in other commercial contracts.
What's been your experience with LDs? When do you see them? Have you ever had any problems with enforcement?
