Liquidated Damages Clause: Drafting Checklist For Suppliers

Aroha runs an IT support business in Wellington. A new customer wants a contract term saying Aroha must pay $2,000 for every hour their platform is offline, even though the monthly service fee is only $4,000.

That might sound like a clear way to manage risk. But if the number is too harsh, unclear or disconnected from the likely loss, it may not work the way the customer expects - and it may leave Aroha taking on a risk she can't sensibly price.

A well-drafted liquidated damages clause can be useful in New Zealand commercial contracts, including customer contracts and supplier agreements. The trick is making it commercially fair, easy to calculate and much more like a genuine estimate than a punishment.

What Is A Liquidated Damages Clause?

A liquidated damages clause is a contract term that sets an agreed amount payable if a specific breach happens.

In supplier contracts and service agreements, you'll usually see it used for:

• Delay damages, such as a daily amount if delivery, installation or completion is late
• Service level damages, such as a service credit if uptime, response times or support targets aren't met
• Milestone failures, such as a fixed amount if a project stage isn't finished by an agreed date
• Repeated performance failures, such as credits after a set number of missed pickups, cleaning visits or stock replenishments

The main benefit is certainty. Instead of arguing later about the exact loss, both sides agree upfront what the consequence will be.

For customers, this can make the contract feel more practical because there's a clear remedy if the supplier falls short. For suppliers, it can help limit open-ended damages, as long as the clause is drafted with proper caps and exclusions.

The phrase liquidated damages clause NZ is often used when people are checking whether these clauses are enforceable locally. The answer depends less on the label and more on how the clause works in practice.

Are Liquidated Damages Enforceable In New Zealand?

Yes, liquidated damages can be enforceable in New Zealand, but a clause can run into trouble if it's really a penalty.

New Zealand courts look at substance over wording. Calling a payment liquidated damages doesn't automatically make it enforceable. The clause should protect a legitimate business interest and shouldn't be out of all proportion to that interest.

In plain English, the amount should make sense when the contract is signed. It doesn't need to be perfectly accurate, and it can still apply even if the actual loss later turns out to be higher or lower. But it should be capable of being explained as a genuine commercial estimate, not a threat designed to force performance.

Penalty risk is higher where the clause:

• Charges the same amount for very different types of breach
• Requires a large payment for a minor or technical failure
• Has no relationship to likely loss, inconvenience, wasted time or replacement costs
• Lets the customer recover liquidated damages and full general damages for the same loss
• Applies even where the delay was caused by the customer or an event outside the supplier's control

If you're using standard terms of trade with smaller business customers, also think about the Fair Trading Act 1986. New Zealand's unfair contract terms regime can apply to standard form small trade contracts, so one-sided default clauses may attract extra scrutiny. If consumers are involved, the Consumer Guarantees Act 1993 may also affect what you can and can't exclude.

How Do You Set A Genuine Pre-Estimate?

You set a genuine pre-estimate by working through the likely loss before the contract is signed, then choosing an amount you can justify commercially.

You don't need a perfect spreadsheet, but you do want a record of your thinking. If the clause is challenged later, it helps to show that the number wasn't plucked from the air.

A Worked Example

Say your IT services agreement covers point-of-sale software for a retail customer at $3,000 per month. The customer asks for service credits if uptime drops below 99.5% in a calendar month.

You might model the likely impact like this:

• The customer has 20 stores using the system
• A serious outage could require extra staff time and manual processing
• The customer may need your support team to prioritise a fix
• The monthly fee is $3,000, so unlimited credits would be commercially unrealistic

A more workable structure might be:

• 99.0% to 99.49% uptime: 5% credit of that month's fee, being $150
• 98.0% to 98.99% uptime: 10% credit, being $300
• Below 98.0% uptime: 20% credit, being $600
• Total credits capped at 20% of the monthly fee

That structure is easier to defend than a flat $2,000 per hour outage payment. It scales with the seriousness of the issue, ties back to the fees and keeps the supplier's exposure within a risk it can price.

For delay damages, you can use the same thinking. Look at likely project management costs, lost productivity, temporary replacement costs, wasted marketing spend or other foreseeable consequences. Then document why the daily or weekly rate is a fair estimate.

What Should A Liquidated Damages Clause Include?

A liquidated damages clause should clearly identify the trigger, the amount, the calculation method, any cure period, the cap and how it interacts with other remedies.

Vague wording is where many clauses fail commercially, even if the legal idea is sound. A clause that says the supplier must pay damages for any delay might create more arguments than it solves.

Fill-In Drafting Outline

This outline isn't a finished clause. A legal adviser should tailor it before you use it, because small wording changes can affect enforceability and commercial risk.

1. Trigger Event: State exactly what failure activates the payment, such as failure to deliver by the agreed delivery date or failure to meet a named service level.
2. Measurement Period: Set the period used for measurement, such as each calendar month, each milestone or each day after the deadline.
3. Calculation Method: Explain the amount payable, such as a fixed daily amount, a percentage of the monthly fee or a tiered service credit.
4. Cure Period: Give the supplier a set period to fix the issue before damages start, where that makes commercial sense.
5. Customer Dependencies: Exclude delays caused by the customer, such as late approvals, missing information or unavailable access.
6. External Events: Exclude events outside the supplier's reasonable control, and align this with your force majeure clause.
7. Cap: State the maximum liquidated damages payable, either per event, per month, per milestone or over the whole contract.
8. Exclusive Or Additional Remedy: Say whether the liquidated damages are the customer's only remedy for that specific failure, or whether other remedies can still apply.
9. Claim Process: Set how and when the customer must claim, including any notice requirement and supporting records.
10. Tax And Invoicing Treatment: Clarify whether the amount is paid, credited against fees or applied to future invoices, and get tax advice if GST treatment is uncertain.

For service level damages in a service level agreement, you should also define how performance is measured. For example, say whether uptime excludes scheduled maintenance, emergency maintenance, third party hosting failures or problems caused by the customer's systems.

How Do Caps, Cure Periods And Exclusions Work?

Caps, cure periods and exclusions keep the clause commercially workable by narrowing when damages apply and limiting the supplier's total exposure.

Without these protections, a liquidated damages clause can become much bigger than the contract value. That's bad for suppliers, and it can also make the clause look more like a penalty.

Caps

A cap sets the maximum amount payable. You can structure it in different ways, such as:

• A dollar cap per day, week or month
• A percentage of the monthly fees
• A percentage of the fees paid for the affected project stage
• An overall cap for all liquidated damages under the contract

For suppliers, the cap should match your pricing, insurance position and delivery risk. For customers, the cap should still be high enough to create a meaningful remedy if the failure happens.

Cure Periods

A cure period gives the supplier a chance to fix the issue before damages start. This can be sensible where the customer mainly wants performance, not a payout.

For example, if a supplier misses a reporting deadline by one business day but fixes it immediately, a cure period may avoid an unnecessary argument. For hard deadlines, such as an event installation date, a cure period may not make sense.

Exclusions

Exclusions stop damages applying where the supplier wasn't truly responsible. Common exclusions include:

• Customer delays in giving approvals, content, stock, data or site access
• Changes requested by the customer after the timeline was agreed
• Third party platform outages that the supplier doesn't control
• Scheduled maintenance, where notice has been given
• Force majeure events, such as severe weather or major supply chain disruption

These details aren't just technical. They help both sides price the contract properly and reduce arguments if something goes wrong.

What If The Deadline Or Service Level Is Missed?

If a deadline or service level is missed, start by checking the contract process before you demand payment or offer a credit.

A calm, well-documented response usually puts you in a stronger position than an emotional email chain. Whether you're the supplier or the customer, work through the facts first.

Step-By-Step

1. Check The Trigger: Confirm that the exact event described in the clause has happened.
2. Check The Measurement: Use the contract's method for counting days, uptime, response times or failed milestones.
3. Check The Cause: Identify whether customer delay, third party failure or an excluded event contributed to the problem.
4. Check The Cure Period: See whether the supplier still has time to fix the issue before damages apply.
5. Calculate The Amount: Apply the formula exactly, including any daily rates, percentage credits and caps.
6. Keep Records: Save system logs, delivery records, approval emails, meeting notes and notices.
7. Send The Required Notice: Follow any notice process in the contract, including who to send it to and when.

If you're a supplier, don't automatically accept a claim that goes beyond the clause. For example, if the contract says service credits are the only remedy for an uptime failure, the customer may not be able to claim extra damages for that same issue.

If you're a customer, don't assume you can withhold any amount you choose from the next invoice. The contract may require a formal claim, a credit note process or a set-off right before you can deduct anything.

If the relationship is ongoing, it's often worth fixing the operational problem at the same time. For example, you might update delivery dates, add clearer customer approval deadlines or change the support escalation process so the same issue doesn't keep repeating.

Key Takeaways

• A liquidated damages clause can be enforceable in New Zealand if it protects a legitimate business interest and isn't an out-of-proportion penalty.
• The amount should be a genuine pre-estimate or commercially sensible measure of likely loss when the contract is signed.
• Good drafting should cover the trigger, calculation method, cure period, exclusions, caps and claim process.
• Service level damages often work best as tiered credits tied to fees, rather than large fixed payments.
• Suppliers should exclude customer-caused delays and events outside their reasonable control.
• Customers should make sure the clause gives a practical remedy without creating a penalty risk.

If you'd like help with your supplier contracts, service level clauses, delay damages wording or liability caps, you can reach us at 0800 002 184 or team@sprintlaw.co.nz for a free, no-obligations chat.