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