§ 19-28 Contract - Damages - Liquidated Damages

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§ 19-28 Contract - Damages - Liquidated Damages

Liquidated damages is the amount agreed upon by the parties when the contract is entered into as the sum to be paid if the contract is breached. It is an estimate made by the parties at the time of making the contract of the extent of the injury which a breach of the contract will cause. Liquidated damages is a sum to be paid in the event of nonperformance. Provisions for liquidated damages are valid and enforceable, so long as they are not actually in the nature of a penalty.

The distinction between a penalty and liquidated damages is that a penalty is in effect a security for performance, while liquidated damages are for a sum to be paid in lieu of performance. A penalty is designed to punish for a breach of contract; whereas, liquidated damages are intended as fair compensation for the breach. A penalty is designed to prevent a breach by the threat of punishment.

In order for a provision for payment of a stated amount on breach of contract to be considered as a provision for liquidated damages, it is required that the damages to be anticipated are uncertain in amount or difficult to be proved; that the parties intended to liquidate them in advance; and the amount stated is a reasonable one that is not greatly disproportionate to the presumable loss or injury.

A contractual provision requiring payment of a stipulated sum by one of the parties upon termination or cancellation of the contract will be treated as an enforceable liquidated damages provision rather than an unenforceable penalty only if all three of the following factors are present:

(1) the injury caused by the breach must be difficult or impossible of accurate estimation;
(2) the parties must intend to provide for damages rather than a penalty; and
(3) the stipulated sum must be a reasonable pre-estimate of the probable loss resulting from such a breach.

Where a designated sum is inserted into a contract for the purpose of deterring one or both of the parties from breaching it, it is a penalty.

Parties to a contract may stipulate as to the amount of liquidated damages owed in the event of nonperformance. Where, however, the sum stipulated is plainly disproportionate to any probable damage resulting from breach of contract, the stipulation is an unenforceable penalty.

Generally, parties to a contract may agree in advance about the amount to be paid as compensation for loss or injury which may result from a breach of the contract when the actual...