As suggested in “The Effective Use of Liquidated Damages Provisions,” there can be a fine line between an enforceable liquidated damages provision and an unenforceable penalty clause. Thus, when drafting an agreement, it is important to keep in mind that a payment-for-breach provision will only be enforceable if, at the time of drafting:
- It would be difficult to determine the damages that would be caused if the contemplated breach were to occur; and
- The amount of the of the liquidated damages is a reasonable estimate of the actual damages that your company would suffer if there were a breach.
In light of these overarching principles, be sure that the contract expressly states that:
- All parties agree that if a breach were to occur, it would be difficult to determine actual damages;
- Based on what the parties presently know (include specifics if you can), they agree that $X is a reasonable estimate of the damages that would accrue if a breach occurred in the future; and
- All parties agree that the amount of liquidated damages is fair and reasonable and would not act as a penalty to the breaching party.