What Are Liquidated Damages?

Liquidated damages are incorporated in certain legal contracts as an estimate of otherwise intangible or hard-to-define losses to one of the parties to the contract. It's a provision that allows the payment of a specified sum to be paid should one of the parties violate the agreement.

Liquidated damages are awarded as a fair representation of losses in cases where actual damages are hard to ascertain. Normally, liquidated damages are designed to be fair, rather than punitive.

Liquidated damages refer to circumstances where a party might face a loss from assets that do not have a direct monetary correlation. For example, if a party were to leak supply chain pricing information crucial to a business that causes a loss of revenue, this could fall under liquidated damages.

A common example is the design phase for a new product which can involve consultation with outside suppliers and consultants in addition to a company’s employees. The underlying designs or a product might not have a set market value. This can be true even if the subsequent product is vital to the progress and growth of a company.

These plans could be the company’s trade secrets and could be highly sensitive. If these plans were exposed to a third party by a negligent employee or stolen by a supplier, it would influence the ability of the company to make any revenues from the release of that product. Therefore, the company could incorporate such a clause in its contract to avoid such a loss and estimate the cost.

It’s possible that the court might not enforce the liquidated damages clause. This can happen when the estimated cost of the monetary damages is much higher than the cost the breach caused the non-breaching party.

Such limitations might affect the plaintiff in recovering a high amount of monetary damages from the defendant. For example, the plaintiff would not be able to recover damages that affected a certain portion of the operation. This clause gives leverage to the parties to seek out a favorable settlement outside of the court.

The principle of liquidated damages is related to the harm or injury to the plaintiff as compensation rather than a fine imposed on the defendant.

Unliquidated damages are similar to liquidated damages in terms of compensating the party who was harmed due to the damages incurred. The difference is that the unliquidated damages are not predicted or estimated at the time of the contract formation as the liquidated damages are.

When a party breaches a contract, the court awards three types of damages as a form of money the plaintiff may seek to win.

• Punitive damages to impose additional punishment on the breaching party

• Economic damages to be awarded money or other financial losses

• Non-economic damages to impose additional punishment on the breaching party.