General damages or liquidated damages: understanding the key differences and how to determine which to incorporate into your commercial contracts
This article provides a refresher on general damages and liquidated damages, the key differences between them, and how to determine which is best to incorporate within your commercial contract in a bid to maximise the protection offered to your business.
In the absence of a liquidated damages clause, general damages will likely apply by default. A general damages clause is typically used to offer protection for any breach of contract claim, including delayed completion.
The amount of damages to be awarded under a general damages clause is not fixed but will instead reflect the actual losses caused by the breach. The contractual principles of foreseeability, remoteness, and duty to mitigate will come into play in quantifying the actual losses suffered and, in return, the amount of damages to be awarded.
A liquidated damages clause will specify a fixed sum agreed between the parties that would be payable as damages for loss caused by a specific breach of contract such as delayed completion. The amount set will be the amount payable irrespective of the loss actually suffered.
Key differences between general damages and liquidated damages
Amount of damages awarded
Cannot be pre-determined
Agreed between the parties and incorporated into the contract
Will depend on the actual loss suffered after the breach occurs
Provides certainty for each party
Creates uncertainty on what may be recovered or paid out if liable
Requirements to successfully claim damages
Must prove the actual losses suffered
No requirement to prove losses suffered
Must illustrate that the damages claimed are a foreseeable consequence of the breach and not too remote
No foreseeability requirement
Potentially requires evidence, such as an expert delay witness and a delay analysis, to prove the foreseeability requirement
No requirement to mitigate losses
The claiming party is under a duty to mitigate their losses
Recent case law has highlighted how a liquidated damages clause will be deemed unenforceable if it appears to be punitive in nature. To avoid this, it is advisable that the fixed amount agreed is set at a level that protects a legitimate commercial interest. As good practice, the receiving party should have calculations in place to justify that the amount set reflects a genuine pre-estimate of the potential loss.
Such clauses are often drafted to cap the damages available to a limited period, limited amount or a percentage of the contract's worth. When drafting, consideration should be made towards what will happen when the cap set has been reached – i.e. what legal recourse will be available to the receiving party if they continue to incur losses.
This illustrates the importance of care being taken when drafting such clauses.
If you are in the process of entering into a commercial contract that contains a general damages clause or a liquidated damages clause and want reassurance that your business is not being unreasonably exposed to risk as the party providing the service, or alternatively that you are being offered the correct level of protection as the receiving party, please get in touch with our experts.