How to Effectively Draft and Design Liquidated Damages Clauses

“Well-structured Liquidated Damages Clauses provide certainty, incentivize performance and facilitate the recovery of damages without difficulty and expense of proof.”

Effective use of Liquidated Damages provisions is a significant risk management tool for both the Employer and the Contractor.

The purpose of the Liquidated Damages Clauses is to provide a quick and easy way to compensate the Employer’s loss rather than punishing the Contractor.

For valid and enforceable Liquidated Damages Clauses, it is of great importance to consider the below mentioned steps.

1   Understanding the Legal Rules and Enforceability 

It is important to understand the area of law dealing with the Liquidated Damages and the basic elements regarding enforceability.

2   Reasonable Valuation of the Damage Amount

One of the key issues while drafting the Liquidated Damages Clause is the determination of the reasonable damage amount.

2.1 Initial Calculation

Determine a reasonable and genuine pre-estimate amount of losses likely to be suffered upon a breach.

Document the calculation of the amount properly to use in the event of a challenge. The calculation methods and formulas of liquidated damages is of great importance as it may be the sole remedy for the Employer.

Avoid cumulative calculations of the Liquidated Damages.

If it is applicable, enable sharing the damage risk with the subcontractors.

2.2 Identifying the Limits

After determining the loss for each key milestone using a reasonable formula, the maximum of the amount of the Liquidated Damages is to be identified.

2.3 Balancing the Risk of Inadequate Liquidated Damages

In some cases, the amount of actual damage may be greater than the estimated liquidated damage amount.

In order to properly balance and mitigate the risk of damage, the Employer is to be aware of not setting an amount which is too low.

3   Arranging Certain and Definitive Terms

Determine the “Commencement Date for Payment”.

Determine the “Duration for Payment”.

Ensure that the Liquidated Damages clause is not void for uncertainty.

This information is provided for your convenience and does not constitute any “Legal Advice”. This document is prepared for the general information of the interested persons. This should not be acted upon in any specific situation without appropriate legal advice.

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