Liquidated damages are a clause that may be included in legal contracts. In this article, we’ll define the term “liquidated damages” and explain what might happen to them in bankruptcy proceedings. 

Key Takeaways

• Liquidated damages can be included in legal contracts to estimate losses that are hard to ascertain
• If either party breaches the contract, the liquidated damages sum will be paid instead of actual damages being calculated
• Liquidated damages are often used for trade secrets and confidentiality agreements
• For liquidated damages clauses to be enforceable, the damages must be difficult to estimate and the amount must be reasonable and not a penalty
• Liquidated damages clauses have been deemed unenforceable in the past by bankruptcy courts

What Are Liquidated Damages?

Liquidated damages are sometimes included in legal contracts as a way to estimate losses to one of the parties that hard to define. Rather than to be punitive, the intention of liquidated damages is to fairly represent losses in situations where actual damages are difficult to determine. 

The liquidated damages provision allows for the payment of a certain sum if either of the parties is found to be in breach of contract. In this situation, the parties do not calculate actual damages but rather the breaching party simply pays the predetermined sum. 

Example of Liquidated Damages

Imagine there was a business working with an outside supplier. The business is still in the design phase for a new product, and their designs are highly sensitive. If the supplier were to leak the design, the company would not be able to generate as much revenue from the release of the product. To cover such losses, the compnay could make an estimate in advance of what this type of loss would cost and include it in the liquidated damages clause of their contract with the supplier. 

Conditions of Liquidated Damages

In order to be enforceable, a liquidated damages clause must meet the following criteria:

• The damages must be difficult to estimate at the time that the contract is signed. Things like confidentiality agreements or theft of trade secrets are likely to fit here while loss of sales is not. 
• The liquidated damages amount must be reasonable and not a penalty. If the amount is disproportionate to actual harm incurred, a court may find that it was intended as a penalty and not enforce the provision. 

Liquidated Damages and Bankruptcy Law

If a contract is breached before or during bankruptcy proceedings, the liquidated damages may fall under the jurisdiction of the bankruptcy court. The party seeking to enforce the liquidated damages provision will need to prove that the calculated liquid damages were difficult to ascertain at the time of the contract’s signing and that they were not intended as a penalty. 

Recently, the Bankruptcy Court for the Southern District of New York decided in a landmark case involving the debtor Republic Airways that a liquidated damages clause was unenforceable, suggesting a potential precedent for future bankruptcy proceedings.