Australia: What are liquidated damages and how are they different from unliquidated damages?

A common concern when drawing up a construction contract (as with most contracts) is what happens if a party fails to comply with their contractual obligations? One possible answer is that they'll be ordered to pay compensation in the form of liquidated damages. You may have encountered this term before, but might not be 100% clear on what it means (don't worry if this is the case, you're in good company). Let's have a look at how this type of damages works, and how it differs from its counterpart – unliquidated damages. 

SO, WHAT ARE UNLIQUIDATED DAMAGES? 

Unliquidated damages are a form of compensation – the value of which hasn't been predetermined contractually – awarded to a party for a loss suffered because of another party's actions (or inactions). The value of this type of damages is "at large", meaning the amount isn't stated explicitly in a contract. Instead, the amount of these damages are determined through the courts by a judge or jury, following a breach of the contract. While harder to prove than liquidated damages, they allow for recovery of losses that are impossible to foresee or estimate with any certainty before the breach occurs. 

For example, if a building company failed to complete a project to the specifications outlined in the contract, leaving their client to demolish and rebuild, they may be liable for uncapped unliquidated damages commensurate with the total cost of remediating the work. 

WHAT ARE LIQUIDATED DAMAGES? 

Liquidated damages (also known as agreed damages) involve a predefined or ascertainable sum of money to be paid from one party to another, in the event of a breach of a clause stipulated within the contract. These amounts should be genuine estimates of any loss that would be incurred by the aggrieved party resulting from a breach by another party. In liquidated damages claims, there is no onus to prove losses, only that the relevant clause has been breached. 

A common way liquidated damages are used in construction contracts is by setting a specific sum per day payable to the property owner for delays in the completion of a project past the agreed-upon date. In some cases the amount paid per day will be calculated as a percentage of the contract price. 

WHAT ARE THE LIMITATIONS OF THESE TYPES OF CLAUSES? 

Because liquidated damages are based on the principle of fairly compensating an innocent party in the event the other party fails to comply with their contractual obligations, they cannot be applied in a punitive manner. If the amount set out to be paid as liquidated damages is judged by a court to be extravagant or unconscionable, they may not be enforced (even if both parties have agreed to it in the contract). 

THE BENEFITS OF LIQUIDATED DAMAGES TO THE CONSTRUCTION INDUSTRY. 

Ultimately, liquidated damages can be mutually beneficial to property owners and the contractors providing them construction services. For the owners, they bypass the need to undertake inquiries to determine the actual loss or damage suffered, defaulting to a reasonable, predetermined amount. For contractors, they offer the safety net of limited and certain financial exposure in the event of breaches. 

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.