Liquidated Damages Clauses

To succeed in business, you must be enterprising, thoughtful, and diligent. Many of the activities and operations of your business will need to be outsourced to specialist contractors. This is the best way to keep your costs down and your productivity up. However, you must ensure that the vendor you hire does the job properly. Performance standards must be met if you are to get the right value for your money.

That is why any contract you sign must have a liquidated damages provision. The aim of such a clause is ensure that the performing party is motivated to do the job well. It also ensures that you will be adequately compensated—without an expensive lawsuit—if the vendor you hired fails to perform.

What is a Liquidated Damages Clause?

A liquidated damages clause is a means of ensuring that you are compensated if the party you hired fails to do the job. It should include a clause that sets out the specific amount of damages you are to receive if a specific type of breach occurs. This amount will need to be negotiated with the contracted party, but it should represent an estimate of the damages you will sustain if they do not perform to a certain standard.

This specificity is needed to prevent the case from going to court and having a judge determine the amount of money owed by the other party, which can be costly for both you and your contractor.

Liquidated Damages Clause California Example

There has been a great deal of controversy over the enforceability of liquid damages clauses. Some vendors believe they give too much power to one party in a contract and that they undermine the right of due process that every individual and business is entitled to.

California’s Fourth District Court of Appeals has recently clarified the factors that courts will take into account when determining whether a contract with a liquidated damage clause can be enforced. In Vitatech International, Inc. versus Sporn, a breach of contract lawsuit was settled just before it was set to go to trial. The defendant agreed to pay Vitatech $75,000 and executed a stipulation for entry of judgment against them for the full amount Vitatech sought—around $300,000—if the defendant did not pay the $75,000 on time.

The court ruled that the stipulation resolved the claims in dispute in pending litigation, that the defendant did not admit liability in the underlying claims, nor did they admit the amount of damages caused by the underlying breach. In summary, the court ruled that the stipulation could not be deemed a discount. The court also ruled that the $300,000 claim was in excess of the anticipated damages Vitatech might suffer if they did not receive the $75,000 and that it was an unenforceable penalty.

Is Your Liquidated Damages Clause Lawful in California?

In California, it is possible to enforce a liquidated damages clause. The amount agreed to at the time that you and the other party sign the contract must be a reasonable estimate of losses that may be suffered should they fail to perform. If you insist on an amount that aims to punish the other party for falling short of the expected standards, the clause will be considered a penalty and unenforceable.

A liquidated damages clause is considered void in cases in which a party is selling personal property or services intended to benefit themselves, their family, or their household. However, the clause can be enforced in cases in which it is impossible or very difficult to resolve or repair the damage done and the estimate of the latter is reasonable.

Liquidated Damages Contract Law in California

There is no way to keep a liquidated damages dispute out of court. Even if the vendor you hired signed a contract that contains one, they may challenge your right to enforce it. The standards of such enforcement are interpreted by the courts and arbitrators. If you must go through this process, you will need the help of an attorney that specializes in the issue. The court will review the language of the clause in the context of the entire contract. They will also take into account your business relationship with the other party of the circumstances of your agreement and interactions. Hiring an experienced attorney is the best way to enforce the liquidated damages clause that is in your contract.

Determining an Amount That is a Reasonable Estimate of Damages

You should be diligent and informed in determining the estimate of damages that you will incur in the event of a breach. You should consider the same factors as the court will if the clause is ever disputed. Here are a few of the questions you should ask yourself:

  • Did the legal team of the other party participate in the drafting of the contract?
  • Is the liquidated damages clause clear in the contract?
  • Is the amount you are asking for reasonable given how much the prospective damage may cost you?
  • How hard would it be to prove that the other party breached the contract?

You must be mindful of the fact that you may not know the events and circumstances that will surround the enforcement of such a provision—if you ever need to enforce it. You must take great care to come up with enforcement language and a sum of money that will not be invalidated by a court years later. 

Assistance with Negotiating Business Contracts

The only way to ensure that you can draft a sound contract with an effective liquidated damages provision is to hire a business and contract a law attorney who understands the dynamics of these issues. An attorney well-versed in liquidated damage clauses, like the attorneys at Stone and Sallus, will help you navigate damages to obtain appropriate recovery. Your attorney should take the lead in drafting the contract document. You should leave all communication and negotiation with the other side, in their hands. This will ensure that all legal loopholes are avoided and that there is a clear understanding of the meaning and intent of the liquidated damages clause.