What are liquidated damages in a contract?

Liquidated damages refer to a specific amount of money that is predetermined and agreed upon by both parties in a contract, which will be paid if one party fails to fulfill their contractual obligations. This provision is designed to provide certainty and clarity regarding the potential financial consequences of non-performance. By outlining these damages in advance, the parties can avoid the uncertainty and complications of determining actual damages after a breach occurs.

This mechanism is particularly useful in contracts where actual damages may be difficult to quantify. It helps both parties understand the implications of not adhering to the contract, thereby promoting accountability. Unlike punitive damages, which are intended to punish a party for wrongdoing, liquidated damages simply provide a means of compensation for the aggrieved party based on an agreed-upon figure.