What do liquidated damages refer to in contract law?

Liquidated damages in contract law refer to pre-determined damages specified within a contract. They are established by the parties at the time the contract is formed and represent a way to quantify the expected losses that may arise from a breach of contract. This approach serves several purposes: it provides clarity and certainty to both parties regarding the potential consequences of a breach, which can help manage risk, and it alleviates the need to prove actual damages in the event of a breach, thus simplifying the enforcement of the contract.

By agreeing to liquidated damages, both parties recognize and accept that certain breaches may lead to specific losses, making it easier to resolve disputes without litigation over the extent of damages. For example, if a construction contract states that for every day of delay in completion, the contractor will owe a specific amount to the client, that amount is the liquidated damage.

This concept is vital in both commercial and construction contracts, where delays or failures to perform can lead to significant financial implications. Liquidated damages must be reasonable and not punitive; otherwise, a court may not enforce them, deeming them unenforceable penalties instead.