CHAPTER 18
Liquidated Damages

Contracts that include an exchange of money or a promise to perform occasionally contain a liquidated damages provision. Its purpose is to encourage seller to meet the contract requirements through invoking predetermined penalties, which seller must pay if they are non-compliant. The following language exemplifies a standard liquidated damages provision that may be found in many contracts:

If seller fails to deliver the supplies within the time specified in this contract, seller shall, in place of actual damages, pay to buyer as fixed, agreed, and liquidated damages, for each calendar day the sum of $50,000.

It is important that seller understands that damages may be enforceable when 1) the injury is difficult to quantify or is uncertain; 2) the amount is reasonable (damages may be considered reasonable when they are commensurate with the damages the breach has cost buyer); and/or 3) the damages are structured in such a manner that they function as damages rather than as a penalty. Unreasonable liquidated damages are unenforceable; when they are unreasonably large in comparison to the damages rendered, they may be construed to be a penalty. For example, imposition of liquidated damages in excess of the contract price may be considered unreasonable.

A penalty is defined as a sum that is disproportional to the actual harm induced. It acts as a punishment whereas damages equate to the sum of harm actually incurred by buyer.

RISK

Liquidated damages can be quite costly in the event that seller breaches the contract, reducing profit and possibly even eating into cost.

RESPONSE

Always try to resist a liquidated damages provision. If seller finds it necessary to allow for such a clause in order to win the contract, at a minimum, try negotiating the following provisions:

1) Negotiate the lowest possible amount. Ensure that the amount is reasonable. It should not be excessive. Otherwise, it may appear to be a penalty.

2) Incorporate a grace period, after the expiration of which damages commence accrual.

3) Request that a cap be placed on each item, as well as on the total aggregate. Try to keep within line of the profit margin so that it does not cost seller money to perform the contract.

4) Ensure that seller is not held liable for liquidated damages when the failure to meet the requirement falls outside seller’s control, e.g., weather, fire, acts of government, floods, epidemics, quarantine restrictions, strikes. See force majeure for further detail on the definition and understanding of excusable delays.

5) Make certain that the damages are the exclusive monetary remedy for claims or losses due to seller’s failure to meet a contract requirement.

6) Avoid inclusion of nullifying language in contracts such as “notwithstanding anything to the contrary, the buyer has all applicable rights under the law.” Such language has a propensity to invalidate exclusivity language that would otherwise limit monetary damages to the liquidated damages provision.

A few possible arguments that seller may use when trying to negotiate liquidated damages from the contract include the following:

1) If the amount seems outlandish and bears no reasonable relationship to the damages actually incurred, argue that they are unenforceable given that they may be perceived to be a penalty. Ask that buyer delete it from the contract.

2) In the event that buyer is requesting reparations for late delivery, yet seller’s delivery is not critical to buyer’s overall program, argue that there is no justification for the liquidated damages provision since buyer will not suffer monetary damages of their own as a result of seller’s late delivery.

3) When damages are not quantifiable, seller should use this as a basis to have them stricken from the contract.

If buyer requires that the liquidated damages provision remain intact, seller may argue that they will incur additional risk as a result; additional risk may be used to justify increased profit or accelerated payment.