What are liquidated damages in a contract?

Liquidated damages in a contract refer to a predetermined amount stipulated within the contract itself that is agreed upon by both parties for specific events that may cause a loss. This amount is established at the time the contract is formed and serves as a compensation amount if a certain breach or failure occurs.

The purpose of liquidated damages is to provide clarity and predictability for both parties regarding the consequences of specific breaches, thus minimizing disputes over the extent of damages in the event of a failure to perform as stipulated. Instead of relying on potentially complicated calculations of actual damages, which can be difficult to determine, the parties agree in advance on the financial consequences of certain actions or failures to act.

This understanding makes it easier for both parties to manage the risks involved in the contract, knowing exactly what the repercussions will be for specific failures. It is important to note that for liquidated damages to be enforceable, they must be reasonable and not serve as a penalty, as this could lead to disputes regarding their validity in court.