How Do Liquidated Damages Work?

Liquidated damages are “penalties” that kick in when you are late delivering on a contract. Note that I put quotes around penalties as many contracts will further state that liquidated damages are not penalties. The clause is often written to include such language as “delays in delivery would have an impact on the program that is difficult to quantify” so we are going to leverage liquidated damages.

I understand the premise behind liquidated damages: essentially, it is an automatic re-negotiation/re-pricing of the contract when a certain event (usually delayed delivery) occurs. The basic tenets of a contract include agreement, product or service, and consideration. When the original contract is negotiated, the parties agreed on the product or service to be delivered at a certain place and time and in a certain quantity at a set price. When one of those conditions is not met, the basic tenets of contracting tell us that the basis of negotiation has changed and, therefore, consideration should also change. In effect, this is where liquidated damages comes into play. The supplier or contractor is late in delivering the product or service and the consideration (payment) should be adjusted accordingly. Read my previous post on this topic for additional information.

That said, I have successfully negotiated away or reduced the liquidated damages clause. Make sure you know the rates, limits, and calculation methods and be willing to challenge the clause!

As for accounting for liquidated damages in your pricing back to a customer, you must be careful not to build so much “fluff” into your price that you are no longer competitive or unable to support your price during an audit.

Contact me directly for additional information or help with your liquidated damages negotiation strategy!

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