What does “liquidated damages” mean in a contract?

Liquidated damages refer to a predetermined amount specified within a contract that a party agrees to pay if they breach the contract, particularly in cases of delays. This provision is often included to provide certainty to the parties involved regarding the potential financial consequences of failing to meet specific contractual obligations, such as completion deadlines.

The intention behind liquidated damages is to estimate the damages that would result from a breach. Instead of vague or indeterminate costs associated with delays or breaches, the contract clearly outlines a fixed sum. This not only allows the non-breaching party to anticipate recovery in the event of a breach but also helps to avoid lengthy litigation over actual damages.

In contrast to a penalty, which may be seen as punitive and often unenforceable in contract law, liquidated damages must represent a reasonable forecast of just compensation for the harm caused by the breach. This is why option one accurately captures the definition of liquidated damages.