When a party to a contract breaches, the fundamental goal of the law is to place the non-breaching party in the same position it would have been had there been no breach. This does not always mean the non-breaching party gets what he sought under the contract. More often, the non-breaching party is awarded money (damages) for adequate compensation.
Penalty or Damage Provisions?
In some instances, the parties to a contract might wish to insert a provision in the contract which specifies the damages the non-breaching party may be entitled to recover. These provisions are called liquidated damage provisions. However, liquidated damage provisions can be found to be unenforceable, when the breaching party seeks to avoid the provision on the ground that it is a penalty. Typically, a penalty is one which greatly exceeds amount of damages actually sustained by the non-breaching party. Court will examine whether the actual damages incurred were much less than the liquidated damages imposed, measured at the time of the breach.
A liquidated damage provision is not a penalty when it reasonably estimates the harm that would result from a breach. But a provision not designed to be a penalty can nevertheless operate as one. The universal rule that damages for breach of contract are limited to just compensation for the loss or damage actually sustained. Accordingly, courts carefully review liquidated damages provisions to ensure that they adhere to the principle of just compensation. A damages provision that violates the rule of just compensation, however, and functions as a penalty, is unenforceable. Liquidated damages must not be punitive, neither in design nor operation.
Courts will enforce liquidated damage provisions when:
Enforcing Liquidated Damage Provisions
To be enforceable the liquidated damage provision, at the time the agreement was made, must meet a two-part test:
Please feel welcome to reach out to our Murray-Lobb Attorneys if you have any further concerns or questions regarding a contract breach or liquidated damage provisions.
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