‘Liquidated damage’ (sometimes also called ‘liquidated and ascertained damage’) is the amount that two entities entering into a contract mutually agree upon and designate as payable in the form of compensation to the injured party by the afflicting party, in the event of some damage or loss occurring to the injured party (examples of which could be delayed performance or an unacceptable quality of deliverable).
Purpose of assigning ‘liquidated damage’
Having a ‘liquidated damage’ clause in an agreement is particularly useful if the financial implication arising out of the future damage cannot be accurately ascertained in advance. Having a ‘liquidated damage’ clause in such instances can then help avoid the hassle of estimating damage, if such an event to actually occur in the future.
Conditions when ‘liquidated damage’ clause can be enforced
More specifically, for a ‘liquidated damage’ clause in an agreement to be upheld and become enforceable, a few conditions have to be necessarily met.
Firstly, at the time when this clause is invoked, the amount designated as liquidated damage should approximately be the same as the actual loss that is incurred by the injured party. This is because the law provides for equitable justice, and any ‘liquidated damage’ clause in an agreement cannot tantamount to unjustifiable benefit and enrichment of any party.
Secondly, as mentioned above, if the loss that is likely to occur from a potentially damaging future scenario is fairly uncertain at the time of entering into the contract, having a ‘liquidated damage’ clause will help both parties avoid undertaking an elaborate impact assessment and financial implication of such an event, were it to actually occur.
However, if the financial loss even at the time of actual damage cannot be fairly ascertained, then it is subject to contingency and is instead referred to as un-liquidated damage.
Difference between ‘liquidated damage’ and ‘penalty’ clause
As stated earlier, ‘liquidated damage’ cannot be awarded to the injured party, if it is likely to benefit from its enforcement more than the loss that has been incurred in financial terms. If that were done, then the purpose of this payout will not be to compensate for the loss incurred by injured party but rather to punish the afflicting party for a breach of the agreed terms in the contract. This however falls under the purview of the ‘penalty’ clause and not the ‘liquidated damage’ clause, in legal terms.
Exceptions when ‘liquidated damage’ cannot be awarded
Apart from the above case, when awarding ‘liquidated damage’ will tantamount to unjustified financial gain for the injured party or severely penalize the afflicting party, this clause is further not enforceable under the ‘Doctrine of Concurrent Delay’ – that is, when the clause of delay or loss can be attributed to the acts of both the contracting parties.
Industries where a ‘liquidated damage’ clause is commonly applied
Two industries where the ‘liquidated damage’ clause is most commonly applied is the financial services industry and the construction industry.
Keywords- Liquidated damage, clause, loss, party