Define: Liquidated Damages

Liquidated damages are a payment agreed to by the parties of a contract to satisfy portions of the agreement which were not performed. In some cases liquidated damages may be the forfeiture of a deposit or a down payment, or liquidated damages may be a percentage of the value of the contract, based on the percentage of work uncompleted. Liquidated damages are often paid in lieu of a lawsuit, although court action may be required in many cases where liquidated damages are sought. Liquidated damages, as opposed to a penalty, are sometimes paid when there is uncertainty as to the actual monetary loss involved. The payment of liquidated damages relieves the party in breech of a contract of the obligation to perform the balance of the contract.

The amount required to satisfy a loss resulting from a breach of contract.

Damages are said to be liquidated (also referred to as liquidated and ascertained damages) when the amount of damages recoverable in the event of a specified breach (e.g., late performance) is agreed at the date of the contract. In such circumstances, a liquidated damages provision will be included in the contract. When damages are not predetermined/assessed in advance, then the amount recoverable is said to be ‘at large’ (to be agreed upon or determined by a court or tribunal in the event of a breach).

At common law, a liquidated damages clause will not be enforced if its purpose is to punish the wrongdoer/party in breach rather than to compensate the injured party (in which case it is referred to as a penal or penalty clause). One reason for this, it could be said, is that the enforcement of the term would, in effect, require an equitable order of specific performance. However, courts sitting in equity will seek to achieve a fair result and will not enforce a term that will lead to the unjust enrichment of the enforcing party.

In order for a liquidated damages clause to be upheld, two conditions must be met. First, the amount of damages identified must roughly approximate the damages likely to fall upon the party seeking the benefit of the term. Second, the damages must be sufficiently uncertain at the time the contract is made that such a clause will likely save both parties the future difficulty of estimating damages. Damages that are sufficiently uncertain may be referred to as unliquidated damages and may be so classified because they are not mathematically calculable or are subject to a contingency that makes the amount of damages uncertain.

For example, suppose Joey agrees to lease a storefront to Monica, from which Monica intends to sell jewellery. If Joey breaches the contract by refusing to lease the storefront at the appointed time, it will be difficult to determine what profits Monica will have lost because the success of newly created small businesses is highly uncertain. This, therefore, would be an appropriate circumstance for Monica to insist upon a liquidated damages clause in case Joey does indeed fail to perform.

In the case of construction contracts, courts have occasionally refused to enforce liquidated damages provisions, choosing to follow the doctrine of concurrent delay when both parties have contributed to the overall delay of the project.

The Law Applied To Bank And Credit Card Charges

This law has recently been of great interest to bank and credit card customers who have been charged as much as £39 for a single transaction that took them over their credit limit. Consumers argued these charges were well beyond the cost of sending a computerised letter.

In 2006, the Office of Fair Trading investigated the excessively high charges being imposed on customers by credit card companies. In its report, the OFT confirmed these charges were unlawful under UK Law as they amounted to a penalty. It said it would be prepared to investigate any charge over £12, though this was not intended to indicate that £12 is a fair and acceptable charge. The OFT said it would be up to a court to determine such an amount based on the established legal precedent that the only recoverable cost would be actual costs incurred.

The credit card companies did not produce evidence of their actual costs to the OFT, instead insisting their charges are in line with clear policy and information provided to customers.

Following the ruling, many bank customers have made County Court claims against their banks and credit card companies for the return of penalty charges for returned checks, direct debits, and unauthorised overdraft charges. To date, no bank or credit card company, save NatWest on one occasion, has attended court for a trial.

This site contains general legal information but does not constitute professional legal advice for your particular situation. Persuing this glossary does not create an attorney-client or legal adviser relationship. If you have specific questions, please consult a qualified attorney licensed in your jurisdiction.

This glossary post was last updated: 10th April 2024.