A liquidated damages, or LD, clause will commonly feature in a contract involving the delivery of a good or service within a stipulated time frame and will be activated when delivery is late. However, it can also be used for other breaches. It is a powerful contractual mechanism, but needs to be drafted correctly in order to be effective.
The key issue when drafting a LD clause is to ensure that the amount of damages stated to be due in the event of breach is a genuine pre-estimate of the loss that the non-breaching party will actually suffer. If it is anything more, you have wasted your time as the clause will be deemed to be a penalty provision and unenforceable at law. This could really impact on the risk profile of the contract so it is worth spending some time to get right.
So, the 1, 2, 3 ...
1. Carefully assess the actual loss that would be suffered as a result of the breach of contract. This will usually be an estimate, however as long as it is a genuine pre-estimate, it should be ok.
2. Ensure the calculated LD amount is not extravagant or oppressive; and
3 .Keep a written record of the calculation carried out to the extent that it is not reflected in the contract so that you can defend an attack on enforceability of the LD clause.If all of that is not possible, you may need to re-draft the contract so that payment is not triggered by a breach of contract but by some other means to avoid the clause being a penalty and therefore unenforceable.
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