What are liquidated damages in the context of contracts?

Liquidated damages refer to predetermined sums for breaches of a contract, meaning that the parties involved agree in advance on a specific amount to be paid if one party fails to fulfill their contractual obligations. This concept serves a crucial purpose in contract law; it provides clarity and certainty to both parties about the consequences of a breach. By establishing a clear financial consequence beforehand, it helps to avoid disputes regarding the extent of damages, which can often be uncertain and difficult to calculate after a breach occurs.

The inclusion of liquidated damages in a contract allows the parties to have a clear understanding of their risks and potential liabilities. This is particularly useful in situations where actual damages might be hard to determine, such as in construction contracts or service agreements where timely performance is crucial. The predetermined nature of liquidated damages can also motivate parties to adhere to the terms of the contract and fulfill their obligations promptly.