What is Liquidated Damages?

Definition

A liquidated damages clause sets a pre-specified dollar amount that one party must pay if they breach the contract. Courts will enforce liquidated damages if the amount represents a reasonable estimate of actual harm at the time the contract was signed, but will strike down amounts that function as a penalty rather than a genuine forecast of loss. This matters because, once agreed, the amount is typically fixed regardless of whether actual damages turn out to be higher or lower. For example, if a construction contract includes a $1,000-per-day liquidated damages clause for late completion, the property owner collects that amount for each day of delay without needing to prove exact losses. Watch for disproportionately large liquidated damages amounts that bear no relationship to realistic harm, as these can function as a financial threat to keep you locked in. Also check whether the clause is mutual or one-directional, since many contracts impose liquidated damages only on the service provider while the other party faces no equivalent penalty for their own delays or breaches.

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