How do you review the liquidated damages clause in contracts?
Locating the liquidated damages clause in contracts is not always straightforward. As the examples below illustrate, sometimes the clause will be in its own clearly marked section, making it easier to identify. Other times, it may be included in a section addressing remedies or damages more generally (see, for instance, examples 9 and 10 below); or it may be buried in the middle of a dense paragraph where it might easily be overlooked (see example 3 below). Contracts may also have more than one liquidated damages clause. One helpful feature of many liquidated damages clauses, however, is that they contain the phrase “liquidated damages” (or those two words in close proximity, as is the case in example 10 below), which can aid reviewers when searching for them.
After locating all the liquidated damages language in each agreement, key things to focus on when reviewing these provisions include:
When liquidated damages become payable. The particular breaches that trigger the obligation to pay liquidated damages will depend on the nature of the agreement. In some cases, the parties may determine that the impact of any breach would be difficult or impossible to quantify, in which case the clause will typically be broad in scope - see, for instance, examples 9, 10 and 14 below where any “Event of Default” triggers this obligation. In other cases, liquidated damages will apply only to specific breaches of contract. Example 1 below, for instance, states that the Service Provider must pay liquidated damages if it competes with the Company by offering services to Customers that are the same as or similar to the “Services” under that agreement. Likewise, example 13 below requires Tenant to pay Landlord liquidated damages if it fails to surrender the Demised Premises in the condition specified by that provision.
Amount of liquidated damages. The amount of liquidated damages will typically be given as, or calculated according to, (i) a fixed amount - see example 7 below; (ii) a (relatively) simple formula - see example 1 below, where damages are 2 times the amount payable for the relevant services under the agreement; (iii) a complex formula - see example 10 below, where damages are the “sum of” items (a) - (d); or (iv) some combination of (i) - (iii) - see example 6 below, where damages are the “lesser of” 3 times the Service Provider’s annualized revenue (simple formula) and US$1 million (fixed amount). One potential pitfall with using a more complex formula is that it may make it difficult for parties to agree on the exact amount of damages in the event they become payable, which may push them into a costly dispute that would negate at least some of the benefit of having the clause in the first place.
Damages not a penalty. Where the amount of liquidated damages is grossly disproportionate to the harm suffered, the damages are more likely to be considered punitive and consequently the clause is more likely to be unenforceable. Accordingly, parties often include language clarifying that the liquidated damages represent a reasonable estimate of the actual damages resulting from a particular breach and are not intended to constitute a penalty (see, for instance, examples 1, 2, 4 and 5 below). In other words, this language is meant to provide greater certainty of the parties’ intentions. Simply including it, however, does not make the clause bulletproof. Depending on the facts and circumstances surrounding a particular contract, a court could still conclude that, despite this language, the damages are punitive or that the clause is otherwise defective and therefore unenforceable.
References to other rights or remedies. Some clauses, such as examples 1 and 2 below, may state that the payment of liquidated damages does not affect other rights or remedies to which the party receiving the damages payment may be entitled. The party obligated to pay liquidated damages, in particular, should also review any sections describing specific rights or remedies mentioned in the liquidated damages clause to get a firm understanding of their total potential liability exposure under the agreement. The Contractor in example 2 below, for instance, should check the indemnification clause in that agreement to ascertain the extent of its obligation to indemnify the City.
As with the review of any contractual provision, it’s also important to be aware of other provisions that may affect the interpretation of liquidated damages clauses. For example, a clause may refer to other sections of the agreement or to particular defined terms (e.g., “Event of Default” in example 9 below and “Critical Performance Standards” in example 15 below), which inform when liquidated damages become payable and therefore need to be reviewed in conjunction with the clause. Similarly, for the purposes of establishing the amount of liquidated damages it may be necessary to review a contract’s pricing terms and/or check relevant defined terms (e.g., “Rent” in example 10 below). Finally, as mentioned above, enforceability is an issue that regularly affects liquidated damages clauses. The enforceability of these clauses typically depends on the facts and circumstances of each case as well as applicable law. The governing law section states which jurisdiction’s laws apply to the agreement, and that information can help parties evaluate potential issues with the enforceability of a given liquidated damages clause.
Software that uses AI to identify and extract liquidated damages clauses (as well as other terms that may affect their interpretation) can accelerate the work of finding these provisions and enable a more comprehensive review than can otherwise be done manually.
Examples of the liquidated damages clause
Below are some examples of liquidated damages clauses from different kinds of agreements. While these examples do not necessarily cover the full range of liquidated damages clauses one may encounter, they are meant to illustrate the degree to which these provisions can vary from contract to contract. Where an example includes broader contextual language, the liquidated damages clause is highlighted in bold.
Example 1: From a Services Agreement
14.3 If, during the Term, Service Provider directly or indirectly, performs, orders or facilitates the performance of any service that is the same as or similar to the Services for a Customer after being introduced to such Customer by Company, Service Provider shall be liable for liquidated damages (and not as a penalty) equal to two times the amount that the Customer would have paid for such services pursuant to this Agreement. Such payment is in addition to any other rights Company shall have pursuant to this Agreement, including termination rights.
Example 2: From a Supply and Service Agreement
6.3 LIQUIDATED DAMAGES
In view of the difficulty of accurately ascertaining the loss and damages which the City will suffer by reason of delay or failure in the performance of the Work hereunder, as a result of the fault or default of the Contractor, it is hereby agreed that liquidated damages shall be due and payable to the City by the Contractor as set forth herein. Such liquidated damages shall not be deemed a penalty. Such liquidated damages may be assessed by the City as a result of the Contractors’ default whether or not the City exercises its rights to terminate the Contractor for default.
The Contractor shall be liable to pay liquidated damages for failures to take and accept Biosolids in accordance with this Contract on or after the Service Date and for deficiencies in performance, provided such failures and deficiencies are not caused by the City. For each day, or part thereof, that the Contractor shall fail or refuse to take or accept Biosolids or otherwise not fully perform its obligations in accordance with this Agreement, the Contractor shall upon demand pay to the City as liquidated damages the amount of $150 per Wet Ton of Biosolids not removed, transported and processed into that quantity of Biosolids Product produced from a unit quantity of Biosolids, that shall be marketed and distributed to an end-user(s) or end-use site(s) for beneficial application to the land, as required hereunder.
The liquidated damages due to the City shall become due and payable at the beginning of each month for the failure or deficiencies experienced by the City in the previous month. The City may elect to have these damages deducted from Lump Sum and Unit Price payments due the Contractor for services provided in subsequent months, provided that the total damages are recovered by the City within six months and any deferred deductions shall be subject to interest at Prime Rate plus 2%. In case the amount which becomes due to the Contractor for performance hereunder shall be less than the amount of damages payable to the City, the Contractor shall pay the difference upon demand by the City.
Liquidated Damages received hereunder are not intended to be nor shall they be deemed either a partial or full waiver or discharge of the City’s rights to indemnification, or of the Contractor’s obligations to indemnify the City, or of any other remedies provided by contract or by Law. Liquidated Damages shall be due and payable as set forth above even in the event of an abandonment of the Work by the Contractor.
Example 3: From a Master Lease Agreement
- USED EQUIPMENT LEASES. For used equipment supplied by Lessor, the following provisions apply: The Equipment is subject to prior disposition at any time prior to Lessor’s acceptance of a signed Supplement. The Equipment is provided “as is,” without any warranty whatsoever by Lessor, in accordance with Paragraph 9. However, provided that the Equipment is unmodified since the date of delivery’ has been manufactured and assembled by or for IBM; and has been installed and maintained by IBM, Lessor guarantees Lessee’s satisfaction with the quality of the Equipment for three (3) months following the “Release Date” indicated on the face of the Supplement. If Lessee is dissatisfied with the Equipment for any reason, Lessee may notify Lessor within three (3) months of the Release Date and, at Lessor’s option, the equipment will either be (a) replaced with equivalent Equipment or (b) returned to Lessor and the Lease terminated and any Rent payments made to Lessor refunded to Lessee. If Lessee cancels its commitment to Lease the Equipment after Lessor signs the applicable Supplement but before the Equipment is delivered and accepted by Lessee, then Lessee shall be liable to Lessor for three (3) months Rent as liquidated damages. Lessor shall bear the risk of loss or damage to the Equipment during transit from the pick-up location to Lessee’s location, provided the Equipment is transported by a carrier designated by Lessor.
Example 4: From a Franchise Agreement
b. Liquidated Damages. Franchisee acknowledges that, if there is any act in violation of Sections 18.1 or 18.2 of this Agreement, it will be impossible to determine with specificity the damage to Franchisor. Therefore, for purposes of this Agreement, as liquidated damages and not as a penalty, for each day that Franchisee is in violation of Sections 18.1 or 18.2 of this Agreement, Franchisee shall pay to Franchisor the sum of $500.
Example 5: From a Franchise License Agreement
d. Liquidated Damages upon Termination. You acknowledge that the premature termination of this Agreement will cause substantial damage to us, the actual amount of which will be difficult to determine. Therefore, if we terminate this Agreement under Subparagraph 14.a. or 14.b. as a result of your breach of this Agreement, or if you owe Liquidated Damages pursuant to Subparagraph 12.b. of this Agreement, or if you unilaterally terminate this Agreement, you will pay us Liquidated Damages for the premature termination of the Agreement. You will owe Liquidated Damages in addition to any outstanding fees and charges owed to us or any of the Entities accruing through the date of termination. Payment of Liquidated Damages is due the earlier of thirty (30) days following termination or the Closing of any Change of Ownership transaction in which a New License is not entered into; except that, if Liquidated Damages become due pursuant to Paragraph 12.b., payment is due thirty (30) days after our demand. Nothing in this Paragraph gives you any right to terminate this Agreement, but provides for the calculation of damages in the event you do so.
You agree that Liquidated Damages are not a penalty and represent a reasonable estimate of the minimum just and fair compensation for the damages we will suffer as the result of your failure to operate the Hotel as a System Hotel in compliance with this Agreement for the full License Term, assuming that we would be able to replace the Hotel in the market within a reasonable time.
Liquidated Damages for premature termination will be calculated by adding the result of (1) plus the result of (2) where:
(1) is calculated by multiplying the average monthly Gross Rooms Revenue of the Hotel for the twenty-four (24) full calendar-month period immediately before the month of termination by the Monthly Royalty Fee percentage under this Agreement, without applying any discount to the standard fee percentage (this product being the “Average Monthly Royalty Fees”), then multiplying the Average Monthly Royalty Fees by thirty-six (36), or by such lesser multiple as would represent the remaining full or partial months between the date of termination and the expiration of the License Term. If the Hotel has been open and operating as a System Hotel for less than twenty-four (24) months, then we will multiply thirty-six (36) by the greater of (i) the Average Monthly Royalty Fees from the date the Hotel opened as a System Hotel through the month immediately before the month of termination, or (ii) the product of the average Monthly Gross Rooms Revenue per Guest Room of all System Hotels in operation in the US over the twelve (12) full calendar-month period immediately before the month of termination, times the Monthly Royalty Fee percentage under this Agreement (without applying any discount to the standard fee percentage) multiplied by the number of Guest Rooms in the Hotel; and
(2) is calculated by multiplying the average monthly Gross Rooms Revenue of the Hotel for the twenty-four (24) full calendar-month period immediately before the month of termination by the Monthly Program Fee percentage under this Agreement, without applying any discount to the standard fee percentage (this product being the “Average Monthly Program Fees”), then multiplying the Average Monthly Program Fees by twelve (12), or by such lesser multiple as would represent the remaining full or partial months between the date of termination and the expiration of the License Term. If the Hotel has been open and operating as a System Hotel for less than twenty-four (24) months, then we will multiply twelve (12) by the greater of (i) the Average Monthly Program Fees from the date the Hotel opened as a System Hotel through the month immediately before the month of termination, or (ii) the product of the average Monthly Gross Rooms Revenue per Guest Room of all System Hotels in operation in the US over the twelve (12) full calendar-month period immediately before the month of termination, times the Monthly Program Fee percentage under this Agreement (without applying any discount to the standard fee percentage) multiplied by the number of Guest Rooms in the Hotel.
Example 6: From a Technology Consulting Services Agreement
- Liquidated Damages. Company and the Shareholders acknowledge and agree that Service Provider will be incurring significant expense in order to fulfill its obligations under this Agreement. Company and the Shareholders further acknowledge that breach of this Agreement by any of them would cause Service Provider and Service Provider’s stockholders significant damages and perhaps the complete cessation of Service Provider’s business. Since the exact amount of such damages would be extremely difficult, if not impossible to calculate, Company and the Shareholders agree that in the event of the material breach by any of them of this Agreement, which breach has not been cured within sixty (60) calendar days of receipt of notice from Service Provider of such material breach and a description of such breach, Company and the Shareholders, jointly and severally, will be obligated to pay to Service Provider liquidated damages in an amount equal to the greater of (a) three time(s) the annualized revenues of Service Provider for the last completed fiscal quarter, or (b) US$1 million.
Example 7: From a Service and Supply Contract
5.2 Liquidated Damages.
5.2.1 Liquidated Damages. The Department will adjust the Contractor’s payment by liquidated damages of $300 for each time the Contractor fails to comply with any of the terms of the Contract including but not limited to those listed below:
188.8.131.52 Insufficient or untimely performance of the Contract;
184.108.40.206 Failure to accept deliveries within the times set forth in the Contract, or to process the number of Collection Vehicles per hour set forth in Section 3.2.3;
220.127.116.11 Rejection of a delivery of MSW;
18.104.22.168 Violation of the Weigh Scale requirements of Section 3.3;
22.214.171.124 Providing incomplete or illegible Delivery Receipts including handwritten or manual Delivery Receipts without the prior authorization of the Department;
126.96.36.199 Failure to maintain complete records of MSW deliveries, or to submit records or other information as set forth in the Contract;
188.8.131.52 Overflow of MSW storage facilities;
184.108.40.206 Failure to update the final Operations Plan as required by Sections 4.4.2 and 4.4.4; or
220.127.116.11 Violation of any of the transport requirements of Section 3.5.
5.2.2 Liquidated Damages Not a Penalty. The parties agree that liquidated damages are not intended as a penalty, but as an acknowledgment by the parties that actual damages in each case are difficult or impossible to ascertain. The Department’s failure to impose damages for any specific violation of the Contract shall not be deemed a waiver of any provision of the Contract, nor shall it be deemed a waiver of any right to impose damages as to other, or future violations of any kind, nor of any other remedy at law or in equity.
5.2.3 Payment of Liquidated Damages. Any liquidated damages due to the Department shall become due and payable on the first day of the month following the date upon which the Department imposes them. The Department may exercise its right of set-off, and deduct the amount of outstanding liquidated damages against amounts due and owing the Contractor from the Department. If the sum due and owing to the Contractor for performance under the Contract in any month is less than the amount of liquidated damages payable to the Department, the Contractor shall pay the difference upon demand by the Department. Any liquidated damages unpaid to the Department for more than one month shall be subject to interest at prime rate in effect at the Federal Reserve Bank of New York upon the date that the interest payment obligation arose plus 2%.
Example 8: From an Asset Purchase Agreement
19.1 Breach by Buyer. In the event that Buyer fails to tender the Purchase Price at Closing, and Seller has substantially performed all of its obligations under this Agreement, as its sole and exclusive remedy, Seller shall be entitled to terminate this Agreement and as its liquidated damages retain the Deposit and Harry Loyle shall surrender any rights to (A) his Area Developer Agreement, and (B) his personal holding of Seller’s shares (approximately 717,016 shares at October 1, 2002).
Example 9: From an Equipment Lease
SECTION 11. REMEDIES. Upon the occurrence of an Event of Default, Lessor may at its option, do any or all of the following: (A) declare immediately due and payable, as liquidated damages for loss of the bargain and not as a penalty, an amount equal to the Casualty Value set forth in the related Schedule, which amount together with all accrued and unpaid payments of Base Rent and any other sums due and payable up to and including the date on which Lessor receives the total of such amount, will be immediately payable by Lessee; (B) terminate the Schedule in default and take possession of any or all Units without any liability to any party for any damage, loss, cause of action or claim and, for this purpose, enter upon any premises where any Unit is located; (C) require Lessee to deliver any or all Units to Lessor in accordance with the return provisions hereof; (D) sell, dispose of, hold, use or re-lease any Unit as Lessor, in its sole discretion may determine by public or private disposition; or (E) proceed by appropriate court action at law or in equity to enforce performance or to recover damages from Lessee for any breach hereof. Upon any sale, re-lease or other disposition of any Unit, Lessor will apply to Lessee’s obligations under the defaulted Schedule the amounts received. Lessor will only be obligated to apply the proceeds of any letter of credit furnished hereunder to the amount set forth in Subsection (A) above. The foregoing remedies in this Section and in Sections 6 and 7 are not intended to be exclusive, but each will be cumulative and in addition to any other remedy referred to above or otherwise available to Lessor at law or in equity. If Lessor is required to enforce its remedies, Lessee will be liable for the deficiency balance payable under a defaulted Schedule, together with all costs, expenses, losses, and damages, including without limitation, all actual court costs, attorneys’ fees and expenses incurred by Lessor, Lessor’s Assignee or any other party in enforcing the terms and conditions of any Schedule or Lessor’s interests, or the priority thereof, in any Schedule or the Equipment.
Example 10: From a Master Lease and Security Agreement
16.3 Damages. (i) The termination of this Lease with respect to any one or more of the Facilities; (i) the repossession of the Leased Property and any Capital Additions of any Facility; (ii) the failure of Lessor, notwithstanding reasonable good faith efforts, to relet the Leased Property or any portion thereof; (iv) the reletting of al or any portion of the Leased Property; or (v) the failure or inability of Lessor to collect or receive any rentals due upon any such reletting, shall not relieve Lessee of its liabilities and obligations hereunder, all of which shall survive any such termination, repossession or reletting. In addition, the termination of this Lease with respect to any one or more of the Facilities shall not relieve Lessee of its liabilities and obligations hereunder with respect to such terminated Facility(ies) that are intended to survive the termination of this Lease, including, without limitation, the obligations set forth in this Section 16.3 and Sections 16.5, 23.1, 37.4 and 45.1.8. If any such termination occurs,Lessee shall forthwith pay to Lessor al Rent due and payable with respect to the Facility(ies) terminated to and including the date of such termination. Thereafter, following any such termination, Lessee shall forthwith pay to Lessor, at Lessor’s option, as and for liquidated and agreed current damages for an Event of Default by Lessee, the sum of:
(a) the worth at the time of award of the unpaid Rent which had been earned at the time of termination with respect to the terminated Facility(ies),
(b) the worth at the time of award of the amount by which the unpaid Rent which would have been earned after termination with respect to the terminated Facility(ies) until the time of award exceeds the amount of such rental loss that Lessee proves could have been reasonably avoided,
(c) the worth at the time of award of the amount by which the unpaid Rent for the balance of the Term for the terminated Facility(ies) after the time of award exceeds the amount of such rental loss that Lessee proves could be reasonably avoided, plus
(d) any other amount necessary to compensate Lessor for all the detriment proximately caused by Lessee’s failure to perform its obligations under this Lease or which in the ordinary course of things would be likely to result therefrom.
As used in clauses (a) and (b)above, the “worth at the time of award” shal be computed by allowing interest at the Overdue Rate. As used in clause (c) above, the “worth at the time of award” shal be computed by discounting such amount at the discount rate of the Federal Reserve Bank of San Francisco at the time of award plus one percent (1%).
Example 11: From a Management Agreement
SECTION 13.8. Upon termination of this Agreement either by the Manager for any reason (other than pursuant to Section 13.4(c)) or by the Partnership pursuant to Section 13.1, the Partnership shall be liable to pay to the Manager as liquidated damages an amount in U.S. Dollars and common units representing limited partnership interests in the Partnership equal to the lesser of (a) ten times and (b) the number of full years remaining prior to the date falling ten years after the last day of the Initial Term times, in each case, the aggregate fees due and payable to the Manager under the terms of this Agreement during the 12-month period ending on the date of termination of this Agreement (without taking into account any reduction to the fees payable to the Manager under Section 9.1(a) in the event that a Submanager has been appointed as provided therein), PROVIDED ALWAYS, that the amount of liquidated damages payable thereunder shall never be less than two times the aggregate fees due and payable to the Manager under the terms of this Agreement during the 12-month period ending on the date of termination of this Agreement.
Example 12: From a Master Services Agreement
(b) Customer may terminate a specified Service after the delivery of a Connection Notice upon 30 days’ written notice to Service Provider. If Customer does so, or if Service is terminated by Service Provider as the result of Customer’s default, Customer will pay Service Provider a termination charge equal to the sum of: (1) all unpaid amounts for Service actually provided; (2) 100% of the remaining monthly recurring charges for months 1-12 of the Service Term; (3) 50% of the remaining monthly recurring charges for month 13 through the end of the Service Term; and (4) if not recovered by the foregoing, any termination liability payable to third parties resulting from the termination and any out-of-pocket costs of construction to the extent such construction was undertaken to provide Service hereunder. The charges in this Section represent Service Provider’s reasonable liquidated damages and are not a penalty.
Example 13: From a Commercial Lease Agreement
- Yield up. To yield up the Demised Premises unto the Landlord at the Termination of the Term so painted treated repaired cleansed maintained amended and kept as aforesaid and otherwise as shall be in accordance with the covenants and conditions contained in or imposed by virtue of this Lease and the keys and all fixtures (other than tenant’s and trade fixtures) of every kind in or upon the Demised Premises or which during the Term may be affixed or fastened to or upon the same and prior to the Termination of the Term to the reasonable satisfaction of the Landlord:
(a) in case any of the said fixtures shall be missing damaged destroyed or beyond repair forthwith to replace them with others of a similar or more modern character and of no less value and
(b) unless released from compliance by written notice given by the Landlord prior to the Termination of the Term to remove from the Demised Premises all tenant’s and trade fixtures and fittings and furniture and effects and signage and if any alterations have been made to the Demised Premises (whether during the Term or during any period of occupation by the Tenant or any undertenant or their respective predecessors in title prior to the date of this Lease) to reinstate the Demised Premises to the condition in which the same were prior to the making of such alterations
(c) to make good any damage caused to the Demised Premises by any such reinstatement or removal or the removal of any fixtures fittings furniture or effects and
(d) to replace the floor coverings laid in the Demised Premises with new floor coverings of the design style material and quality as are fitted at the date hereof or as may be otherwise approved in writing by the Landlord
provided that if the Tenant shall fail to leave the Demised Premises in all respects in the state and condition in which the same should be left the Tenant shall in addition to the reasonable costs of remedying the same pay to the Landlord by way of liquidated damages a sum equal to the proportion of the rents reserved by this Lease at the rates applicable immediately prior to the Termination of the Term payable for the period from the Termination of the Term to the date on which the same shall have been remedied or ought to have been remedied if the same had been remedied as speedily as reasonably practicable.
Example 14: From a Management Agreement
13.5 Liquidated Damages and Limitations on Remedies. The following liquidated damages and limitations on remedies apply under this Agreement, in addition to those provided elsewhere in this Agreement as to claims and remedies against the Band:
13.5.1 Liquidated Damages Payable by Manager. In the event of a Manager Event of Default prior to the Commencement Date, after such notice and right to cure as may be provided in this Agreement, Manager shall pay liquidated damages as provided in ss. 14.5(i) of the Development Agreement and shall not be liable for additional damages under this Agreement.
13.5.2 Liquidated Damages Payable by the Band. In the event of a Band Event of Default prior to the Commencement Date, after such notice and right to cure as may be provided in this Agreement, the Band shall pay liquidated damages as provided in ss. 14.5(ii) of the Development Agreement and shall not be liable for additional damages under this Agreement.
Example 15: From a Supply Agreement
8.2. Failure to Perform.
(a) Supplier recognizes that its failure to meet Critical Performance Standards may have a materially adverse impact on the business and operations of the Company. Accordingly, in the event that Supplier fails to meet a Critical Performance Standard for reasons other than the wrongful actions of the Company or circumstances that constitute force majeure under this Agreement, the Company may elect in lieu of pursuing other monetary remedies to recover as liquidated damages the amounts calculated pursuant to Schedule B (the “Performance Standard Credits”).