Liquidated damages are a means of compensation for the breach of a contract. Often, liquidated damages clauses are found in real estate transactions and other contracts where a specific dollar amount can be hard to determine because of changing circumstances. Because the amount is hard to determine, the parties agree to a specified amount of money that must be paid if one of them fails to adhere to the terms of the contract. The purpose of this agreement is to ensure that the failure of one party to follow the contract does not unfairly hurt the other and the amount agreed to must be a reasonable estimate of any potential damage a breach of contract might cause. Liquidated damages clauses act as insurance for both parties. The person who breaks the contract knows ahead of time how much they would owe the other party. Similarly, the other party can negotiate an amount that would adequately cover their loss without having to go to court. However, the purpose of a liquidated damages clause is not to punish the person that breaches the contract.

Example: Gerald has agreed to purchase Reta’s home for $50,000. As part of the agreement, he must put down a deposit of $5,000. Both parties agree that if either of them does not follow the terms of the contract, the other person gets the $5,000 deposit. If Gerald fails to follow through with the purchase, Reta gets to keep the $5,000. If Reta decides she does not want to sell her home to Gerald, she must return the $5,000.

Sample – Owner/Contractor Agreement:

It is acknowledged that the Contractor’s failure to achieve substantial completion of the Work within the Contract Time provided by the Contract Documents will cause the Owner to incur substantial economic damages and losses of types and in amounts which are impossible to compute and ascertain with certainty as a basis for recovery by the Owner of actual damages, and that liquidated damages represent a fair, reasonable and appropriate estimate thereof. Accordingly, in lieu of actual damages for such delay, the Contractor agrees that liquidated damages may be assessed and recovered by the Owner as against Contractor and its Surety, in the event of delayed completion and without the Owner being required to present any evidence of the amount or character of actual damages sustained by reason thereof; therefore Contractor shall be liable to the Owner for payment of liquidated damages in the amount of One Thousand Dollars ($1,000) for each day that Substantial Completion is delayed beyond the Contract Time as adjusted for time extensions provided by the Contract Documents. Such liquidated damages are intended to represent estimated actual damages and are not intended as a penalty, and Contractor shall pay them to Owner without limiting Owner’s right to terminate this agreement for default as provided elsewhere herein.