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Liquidated damages are pre-agreed sums payable if a party breaches certain contractual obligations. They are often included as a deterrent, giving a clear financial consequence, but if drafted poorly, they can backfire, leaving the party relying on them without protection.
While tempting as a straightforward way to discourage non-compliance, liquidated damages do not always work as intended. UK courts scrutinise whether the sum represents a genuine pre-estimate of likely loss or is effectively a penalty, which would be unenforceable. Overly high, arbitrary, or disproportionate sums can be struck down, leaving the party who relied on them without the protection they anticipated.
Liquidated damages clauses are particularly common in large-value, high-importance contracts, such as major infrastructure projects, complex engineering agreements, specialist commercial arrangements, and contracts involving highly confidential IP, trade secrets, or other commercially sensitive information. They are intended to provide certainty and a financial deterrent against breach, but even in these contracts, they can be challenged, and including a clause may increase the risk of litigation.
Examples of contracts that often include liquidated damages clauses include:
Construction contracts – widely used to provide clarity and certainty where delays occur. They specify an agreed daily or weekly amount payable if completion is late, avoiding the need to prove actual loss and helping both parties manage risk and cash flow.
Confidentiality agreements and NDAs – estimating financial loss is difficult (e.g., reputational harm, loss of competitive advantage), so courts may treat an excessive sum as a penalty.
Software agreements – delays in system delivery or failures to meet performance metrics.
Commercial leases – late vacation of premises or early termination.
Service level agreements – often include service credits for performance failures.
Supply contracts – late or incomplete deliveries.
Distribution agreements – failure to meet minimum purchase requirements.
Outsourcing contracts – complex damages regimes for service failures.
Share purchase agreements – breaches of warranties or covenants.
Poorly though out and/or drafted clauses may be deemed penalties, leaving the innocent party to prove actual damages.To reduce the risk of challenge and improve enforceability:
Tie the clause to specific, high-value breaches, such as delays, missed milestones, or misuse of confidential IP and trade secrets.
Ensure the sum reflects a genuine pre-estimate of loss at the time of contracting, supported by objective data such as projected costs, revenue impact, or historical precedents.
Clearly define the formula or method for calculating damages in the contract, even if exact numbers are not included. This allows parties to demonstrate reasonableness if the clause is challenged.
Be ready to justify how youi calculated the liquidated damages, which may support settlement discussions, and reduce enforcement risk.
Consider tiered or scaled amounts based on breach severity.
Document assumptions and methodology, showing a rational commercial basis.
Avoid punitive or arbitrary sums, which English courts are likely to strike down.
Because liquidated damages can be challenged, good advice is to also consider alternative or supplementary measures, which, depending on the type of agreement, may include :
Performance bonds or guarantees – security for losses if obligations are not met.
Step-in rights – allowing one party to take over obligations if the other defaults.
Injunctions or specific performance clauses – particularly useful for protecting sensitive IP or trade secrets.
Structured incentive/penalty schemes – combining modest penalties with performance rewards.
Enhanced confidentiality measures – monitoring, reporting, or bespoke IP protection clauses.
We advise clients on all aspects of liquidated damages clauses and breach deterrent measures. Our services include:
Drafting and reviewing clauses to ensure they are commercially effective and legally defensible.
Negotiating liquidated damages provisions in high-value, high-importance contracts, including construction, software, NDA/confidentiality, and outsourcing agreements.
Advising on enforceability, calculation methods, and potential exposure.
Advising on alternative breach deterrents such as step-in rights, performance bonds, or structured incentive schemes.
Litigation support and dispute resolution if liquidated damages clauses are challenged, including strategies for justifying sums, demonstrating commercial rationale, and pursuing or defending claims.
Contact us to discuss your contracts and ensure your risk management, enforcement strategies, and dispute preparedness are robust.
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