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What is a Liquidated Damages Clause?

By: Monique L'Italien

Everyone will enter into a contract at least once in his or her lifetime, and realistically most will enter into several contracts. When you enter into a contract with another party, you are placing a great deal of faith in that party. If they do not live up to their end of the bargain, you could sustain serious financial damage as a result. Fortunately, Florida law seeks to remedy this potential situation by allowing parties who are not responsible for the breach of a contract (the non-breaching party) to recover compensation for their damages. In some cases, the amount of damages available can be predetermined by the two parties during the contract formation process. Specifically, this can be done by including what is known as a liquidated damages clause within the contract.

A liquidated damages clause specifies a predetermined amount of money that must be paid as damages for failure to perform under a contract. The amount of the liquidated damages is supposed to be the parties’ best estimate at the time they sign the contract of the damages that would be caused by a breach. For example:

Liquidated Damages: If Acme breaches any of part of this contract, XYZ shall receive, as liquidated damages for such breach, four million dollars ($4,000,000). Acme and XYZ agree that, in the event of a breach of any of this contract, actual damages would be impractical to compute and further agree that the damages set forth herein are a reasonable estimate of the damages XYZ would actually suffer due to such breach.

Benefits of a Liquidated Damages Clause: Liquidated damages clauses have certain benefits. They establish some predictability and can act as a type of insurance against the cost of a breach. Both parties have the advantage of being able to weigh the cost of performance against the cost of breach. In addition, the non-breaching party never has to prove actual damages, which can be a time consuming and difficult task. Done properly, deciding on damages at the outset gives both parties the opportunity to settle on an amount that they think is fair instead of leaving this decision to the courts. Besides the uncertainties of litigation, it is also time consuming and costly.

What Makes a Liquidated Damages Clause Enforceable?
As previously mentioned, when a breach of contract occurs, courts allow for damages to be obtained by the non-breaching party. This is solely because the non-breaching party has likely sustained some type of financial ‘injury’ and that injury needs to be rectified. For this reason, while liquidated damages provisions can have advantages, they are not always enforceable. Several characteristics must be present for damages to be considered liquidated damages. In order to ensure that your liquidated damages clause is valid, it should always conform to the following two criteria:

a) The amount is reasonable and not a penalty: Liquidated damages allow for damages to be predetermined, but that amount of damages may not simply be a random figure. Instead, the specified amount of damages must constitute a reasonable estimate of the real damages that would likely be sustained as the result of a future breach. If the predetermined amount of damages ends up grossly disproportionate to the actual harm suffered, courts may refuse to enforce the provision on the grounds that it is a penalty instead of an estimate of actual damages. To be clear, liquidated damages are not penal or punitive, and in fact, a liquidated damages clause in a contract will be considered void if it appears to be intended as a form of punishment for committing the breach. Rather, the purpose of these damages is to have a clear way to compensate people when another party to a contract fails to execute his or her part of the agreement. Finally, in deciding the reasonableness of a liquidated damages provisions, courts often consider the relative bargaining power of the parties. For example, liquidated damages provisions in preprinted consumer contracts, like car rental agreements and club memberships, are generally subject to higher scrutiny because of the disparity between the relative bargaining power and sophistication of the parties involved. On the other hand, courts are less likely to invalidate a negotiated agreement between two attorneys.

b) Damages are difficult to estimate: There are two main benefits to using a liquidated damages clause: certainty over damages and saving time calculating complex damages in the future. In certain situations, injuries are easy to prove. If, for example, a contractor breaks a tool belonging to a client, the damage is certain: The contractor is liable for the value of the tool. On the other hand, if the contractor runs over schedule on the job, the damages are unclear, because it's not immediately clear how much monetary damage is experienced when overruns occur. That said, liquidated damages for non-performance can be assessed whenever it is clear that a party to a contract failed to perform duties clearly spelled out in the contract. To be enforceable, the damages should be either uncertain or difficult to quantify at the time the contract is entered into.

In sum, caution should be exercised when signing boilerplate contracts, you should be aware the contract may contain a liquidated damages clause. You should understand the situations in which it will be triggered. If you feel the terms of the contract are unfair, you may want to consider requesting a revision of the contract. If you have any questions about the liquidated damages clause in a contract, please contact the Quattro firm’s attorneys to learn more about your legal options and to discuss any breach of contract with a lawyer as soon as possible to determine the best course of action. Likewise, it is advisable to consult with a lawyer when drawing up a contract to make sure that any damages are appropriate. A Florida court may find a flawed liquidated damages clause to be legally invalid.

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