“The tests and standards that courts apply to evaluate whether a particular liquidated damage provision is enforceable vary from state to state and it is imperative that litigants research and fully appreciate the particular standards that will be applied by the court in which they are litigating.”

Abstract: The liquidated damages provision in a contract is a useful mechanism for mitigating risk in the event one of the parties to an agreement breaches the contract, costing the aggrieved party sometimes significant difficulty and substantial expense. Unfortunately, these provisions are often challenged, allowing the party responsible for the beach to exacerbate the burdens on the other party. In this article, the author discusses concepts of enforceability, proof, and avoiding litigation over liquidated damage provisions.

A liquidated damage provision is an advance agreement of the damages that a party will be entitled to recover in the event of a future breach by the other party to a contract. These provisions can be an important tool for risk allocation and mitigation between parties when entering into a contract; both because the provision allows the parties to predict with certainty the financial ramifications of a future breach and because the liquidated damage provision should protect the aggrieved party against the difficulty and expense associated with proving actual damages in the event of a breach.

In reality, however, when a breach occurs, liquidated damage provisions are frequently challenged and become the subject of costly litigation.  At the outset, it should be noted that the enforceability of a liquidated damage provision is generally considered an issue of law to be determined by the court, not an issue of fact to be presented to a fact finder. Thus, the key threshold issue of enforceability is likely to be determined on a pretrial motion rather than at trial and you should be prepared with both evidence and argument in order to sustain your claim.

If you are faced with a challenge to dismiss your claim to recover liquidated damages based on unenforceability, it is important to remember that the law is in your favor.

Liquidated damage provisions are viewed favorably by courts across the country and will generally be enforced so long as a court is satisfied that a liquidated damage provision is a stipulated agreement based on anticipated actual damages and not a penalty. A liquidated damages provision will be considered a penalty, and therefore unenforceable, if the court determines that the provision is designed to induce or secure performance by one party; conversely, a liquidated damage provision will not be viewed as a penalty, and will therefore be enforced if the court is satisfied that the provision is designed not to punish, but to provide a sum certain as compensation for a breach.