Liquidated damages are an exact amount of money, or a set formula to calculate the amount of money, a party will owe if it breaches a contract, in order to compensate the injured party for its losses. Liquidated damages must be clearly stated in a section or clause of a contract and agreed upon by the parties prior to entering a contract. Liquidated damages are a variety of actual damages and a remedy for breach of contract.
Parties to a contract use liquidated damages where actual damages, though real, are difficult or impossible to prove. Liquidated damages provide a clear monetary value to compensate the injured party while saving time and resources on litigation determining compensatory damages. Liquidated damages can also be used to deter parties from breaching contracts.
Legal disputes surrounding liquidated damages arise following a breach of contract when either the injured party believes the liquidated damages are not adequately compensatory or the breaching party believes the liquidated damages are unreasonably high. Courts will not impose liquidated damages if the clause is punitive, illegal, unconscionable, or contrary to public policy.
Example
Undisclosed source code has value as a trade secret. Openly publishing the source code destroys the trade secret value. The trade secret value of source code is difficult or impossible to prove. There is no open market for "secret source code".
In the 1997 equity case of Sun Microsystems, Inc. vs. Microsoft, the plaintiff Sun Microsystems made several damage claims. One was for $35 million in liquidated damages for Java source code disclosure, a contract violation. The case was later settled on terms, including a $20 million payment by Microsoft to Sun.
[Last updated in June of 2023 by the Wex Definitions Team]