Liquidated Damages vs Penalty Clause: Which Contract Provision Is Enforceable?
A liquidated-damages clause estimates loss; a penalty punishes breach.
Liquidated damages
A liquidated-damages provision is more likely enforceable when actual damages are difficult to estimate and the stated amount is reasonable.
Penalty clause
A clause is more likely an unenforceable penalty when the amount is disproportionate to likely loss and mainly punishes nonperformance.
Reasonableness
The analysis focuses on whether the amount reasonably relates to anticipated or actual harm under the governing law.
Exam strategy
Ask whether the amount looks like a good-faith estimate or an excessive threat.
The takeaway
Liquidated damages compensate for reasonably estimated loss; penalties punish breach and are generally not enforced as contractual damages.
Related Summit resources
FAQ
Are all predetermined damage clauses enforceable?
No.
What supports enforceability?
Difficulty estimating damages and a reasonable amount.
What suggests a penalty?
A disproportionate amount intended mainly to punish breach.