Do I Need A Liquidated Damages Clause In My Contract?

Reviewing your contract is one of the most important aspects of any business relationship. If you work in industries such as construction, you may have come across a liquidated damages clause.

Like any other contract, you want to make sure your agreement covers any possibility of non-performance. In other words, what might happen if the job isn’t done as agreed?

This is where a liquidated damages clause might come in handy.

What Is A Liquidated Damages Clause?

Before we delve into the clause itself, it’s important to understand the concept of liquidated damages within the context of New Zealand law.

In New Zealand, a liquidated damages clause specifies the amount of compensation to be paid if a contract is breached. The key feature here is that the amount is predetermined and agreed upon by both parties at the time the contract is formed, rather than being assessed after a breach has occurred.

Liquidated Damages vs Unliquidated Damages

Liquidated damages are distinct from unliquidated damages, which are not fixed in advance and are determined by a court after a breach has occurred, based on the actual loss suffered.

When Would You Need A Liquidated Damages Clause?

In industries like construction, where timely completion is critical, a liquidated damages clause can be particularly useful. It sets out a fixed sum that the contractor must pay to the principal if the project is not completed on time, thus limiting potential disputes over compensation for delays.

Example KiwiBuild Constructions has engaged a contractor, Billie, for a significant construction project. The contract stipulates that Billie must complete the work within 2 months. If Billie fails to complete on time, she is required to pay $2,500 for each week the project remains incomplete, as per the liquidated damages clause in their agreement. Therefore, if Billie finishes the work 2 weeks late, she will owe KiwiBuild Constructions $5,000 in liquidated damages.

What Does It Include?

A liquidated damages clause in New Zealand should be tailored to the specific business relationship, but typically includes:

• Practical completion – the clause should define or include a test to determine whether the work is sufficiently complete to be used for its intended purpose
• Date for practical completion
• Test for breach – at what point is it considered a breach of contract requiring the payment of damages?

How Are Damages Calculated?

The amount of liquidated damages should reflect the potential costs and losses to the principal, including:

• Insurance costs
• Administrative expenses
• Staffing costs
• Losses resulting from project delays

It’s crucial to ensure that the clause is not deemed a penalty, which is unenforceable under New Zealand law. A lawyer can help draft a clause that is likely to be upheld by the courts.

Pros And Cons Of Liquidated Damages

A liquidated damages clause provides an incentive for the contractor to complete the work on time and sets clear expectations for compensation in case of delay. It can also prevent the need for dispute resolution processes, saving time and preserving business relationships.

However, if the sum specified is disproportionate to the actual loss suffered, it may be considered a penalty and thus unenforceable.

How Do You Enforce A Liquidated Damages Clause?

In New Zealand, the enforceability of a liquidated damages clause depends on whether the sum represents a genuine pre-estimate of loss. If it is deemed to be a penalty, the courts will not enforce it.

What Are Penalties?

A penalty is a sum that is not a genuine pre-estimate of loss and is disproportionate to the harm caused by the breach. New Zealand courts will not enforce penalty clauses.

Next Steps

If you’re in an industry where a liquidated damages clause is beneficial, it’s important to have it drafted properly. Sprintlaw has a team of lawyers who can assist with your contract needs. Contact us at [email protected] or call 0800 002 184 for an obligation-free chat.

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