Liquidated damages (also referred to as liquidated and ascertained damages) are damages whose amount the parties designate during the formation of a contract for the injured party to collect as compensation upon a specific breach (e.g., late performance).
In Common law, in order for a liquidated damages clause to be upheld, two conditions must be met.
- First, the amount of the damages identified must roughly approximate the damages likely to fall upon the party seeking the benefit of the term.
- Second, the damages must be sufficiently certain at the time the contract is made that such a clause will likely save both parties the future difficulty of estimating damages.
Here’s a simple example of how the liquidated damages amount can be calculated. Let’s say that the project is the construction of a car parking area which will be used for commercial purposes, renting spaces to visiting drivers. For this example, we will assume the following:
- The car park’s capacity is 200 spaces.
- The hourly rate is £1.
- It will be open for 10 hours per day.
- The car park operates 7 days a week and the charge rate is always the same.
Loss of revenue for the Client on a daily basis if there was a breach of contract and the Contractor failed to deliver this project on the agreed completion date, would be worked out as per the following equation:
Daily loss of revenue = (number of spaces) x (hourly rate) x (operating hours)
* Please note that the above formula cannot be used as a generic rule of thumb on every calculation. It is up to the Client to inform the Contract Administrator of the amount that he’d like to be used for liquidated damages, based on the Client’s calculations.
So for the example above, the amount will be: Daily loss of revenue = 200 x 1 x 10 = £2,000 per day (or £14,000 per week maximum). This represents a rough estimation of the potential maximum daily/weekly revenue loss, however this would not necessarily be the amount that would be set as the penalty for late hand over.
