Liquidated Damages

What it means

A liquidated damages clause fixes in advance what one party pays the other for a specific breach. Rather than proving actual loss after the fact, the contract states the number up front — $500 a day for late delivery, one month's fees for early termination, a set sum for each unauthorised disclosure.

The legitimate purpose is certainty. Some losses are real but genuinely hard to quantify, and agreeing a reasonable figure in advance saves both sides an expensive argument later.

The legal line is between a genuine pre-estimate of loss and a penalty. Courts in many jurisdictions will enforce the former and refuse the latter, and the usual test is whether the sum was a reasonable forecast of harm at the time of signing, not whether it looks proportionate afterwards. A figure that bears no relation to any plausible loss is at risk of being struck out — which is a reason not to rely on an aggressive one you drafted, as much as a reason to push back on one you were handed.

What to check: whether the amount is proportionate to the deal size, whether it is the exclusive remedy for that breach or sits on top of other remedies, whether it runs both ways, and whether it accrues per day, per incident, or as a one-off.

A daily figure with no overall ceiling deserves attention. A $500-per-day charge with no cap becomes $182,500 over a year.

Why it matters for your business

This is a number you agree to owe before anything has gone wrong. An uncapped daily rate on a contract worth a few thousand dollars can generate a liability larger than the entire engagement.

Related terms

• Limitation of Liability — The cap is the number that tells you your worst case.
• Termination for Convenience — A one-sided convenience right converts what reads like an annual contract into a rolling monthly one — for you only.
• Payment Terms — Net 60 terms on a project you funded up front can put a profitable engagement into a cash flow hole.