Why Having a Valid and Enforceable Liquidated Damages Clause in Your Contract is Important?

“Well-structured Liquidated Damages Clauses provide certainty and incentivize the performance of the project.”

Liquidated Damages Clauses do not require expense of proof for recovering damages in the event of specific breaches defined in the contract, such as late performance.

You can compensate damages without;

➤  the need to prove the quantum of actual damages

➤  any unclarity regarding the concept of loss and its calculation

But the critical issue is that the liquidated damages clause should be valid and enforceable.

There should be no room for a penalty.

To achieve that, you should;

➤  determine the reasonable pre-estimate damage amount

➤  properly document the calculation of that amount

➤  identify the maximum amount of the Liquidated Damages

➤  be aware of not setting an amount which is too low

➤  ensure the consistency between the contracts such as the link between the main contract and the subcontract

Understand the procedure and the key issues and draft valid and enforceable liquidated damages clauses.

Build up a quick and easy way to compensate the loss.

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.

1.  Do not constitute a penalty as opposed to a reasonable estimate of the actual damages likely to be incurred due to delay.

2.  Do not forget that proportionality of the damages to the costs reasonably anticipated to be incurred is key for drafting a valid liquidated damages claim.

3. Ascertain the intentions of the parties to liquidate the damages in advance.

4.  Ensure the consistency between the contracts. For example, when the Employer includes a Liquidated Damages provision in the prime contract, the General Contractor should include a similar clause in its subcontract to transfer the risk of liquidated damages to its subcontractors.

2   Reasonable Pre-Estimation of the Damage Amount

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

In commercial projects defining the concept of loss is easy to understand and calculations can be based on figures. But, defining and calculating loss is much harder in public projects.

2.1 Initial Calculation

1. Determine a reasonable and genuine pre-estimate amount of losses likely to be suffered upon a breach. The amount of Liquidated Damages should be the best estimate of the parties at the time they sign the contract.

2. 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

3. Avoid cumulative calculations of the Liquidated Damages.

4. 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

One of the vital functions of the liquidated damages provisions is to give contracting parties certainty as to their risk exposure.

It should be clear.

1. Include the calculated “Pre-Determined and Agreed Sum” representing the damages.

2. Define the “Types of Breaches” that trigger the liquidated damages provision.

3. Define the term “Practical Completion” and make sure a date for Practical Completion is specified.

4. Determine the “Commencement Date for Payment”.

5. Determine the “Duration for Payment”.

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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