I had lunch with the American Society of Professional Estimators (ASPE) the other day and we discussed construction contracts. There were a lot of questions about liquidated damages. As I explained during the meeting, liquidated damages can provide some certainty about damages under a contract, but if the clause is unreasonable, it will not be enforced. Here is some more information on liquidated damages.
What are Liquidated Damages?
Liquidated damages are simply an agreement between the parties as to the sum to be paid in the event of a breach.
Are Liquidated Damages Clauses Enforceable?
Yes. Liquidated Damages clauses will be enforced unless they are a penalty. The court will look to see whether the damages, if pursued, would be difficult to ascertain because of their indefiniteness or uncertainty and where the amount stipulated is either a reasonable estimate of the damages which would probably be caused by a breach or is reasonably proportionate to the damages which have actually been caused by the breach. If the amount of the liquidated damages have nothing to do with the actual damages, the court will not enforce the clause.
How Do I Calculate Liquidated Damages for My Contract?
You will have to think about the damages that you would suffer if the project is delayed or breached in some other way. Would a breach require you to staff additional employees on the project, devote additional resources to the project, obtain additional financing? Come up with a reasonable figure for your damages, then keep the documentation on which you based the liquidated damages. You may have to show why it was a reasonable calculation at the time the contract was signed.
Liquidated damages can be an excellent tool to bring clarity to the risk involved in your projects. But, the amount claimed must be near the actual damages you would suffer because of a breach. This amount can be very difficult to calculate, especially before the project starts.