What Are Liquidated Damages?

Contracts keep businesses running smoothly, but anyone who has signed one knows things don't always go as planned. A missed deadline, a broken promise, or a deal that falls apart can create expensive consequences.

When that happens, the question becomes: how will your business be compensated for the loss?

This is where liquidated damages come into play. They provide both sides with a means to prepare for the financial impact of a potential breach, thereby avoiding disputes over numbers later on.

Business owners across California rely on these clauses to save time, reduce costs, and protect their relationships when contracts fail to hold up.

Below, we explain what are liquidated damages, how they protect businesses in contract disputes, and the legal process for enforcing them.

At Thorsnes Bartolotta McGuire, we help companies protect their business interests and recover millions in losses. Schedule a meeting with one of our business litigation lawyers today by calling us at (619) 236-9363 or contacting us online.

What Does Liquidated Damages Mean?

When two businesses sign a contract, both sides want certainty. If something goes wrong, neither party wants to spend months arguing over numbers or trying to assign a dollar value to losses that are difficult to quantify.

That's where a liquidated damages clause becomes important. It's essentially an agreement made at the outset: if one side breaches the contract, they will pay a set amount of money to the other.

That number is chosen because the actual losses from a breach—things like wasted time, missed opportunities, or delays—would be too difficult to calculate later.

The key is fairness. Courts in California will not enforce an amount that looks inflated or designed to punish. But when properly drafted, these clauses hold up in court and spare businesses from costly arguments over compensation.

In short, the liquidated damages definition is a contract term that establishes a reasonable, pre-agreed-upon amount to be paid if the agreement is breached.

How Liquidated Damages Protect Your Business in Contract Disputes

Once you understand what liquidated damages mean, the next question is why businesses rely on them. Contracts can break for various reasons, such as late deliveries, unfinished projects, or even a partner walking away unexpectedly.

Each of those situations brings real costs, and without a plan in place, those costs can spiral into drawn-out disputes.

A liquidated damages clause provides a safety net. Instead of arguing about the true extent of the loss, both sides already agreed on a number when the contract was signed. This creates stability and helps keep a dispute from draining time, money, and energy.

Here's how these clauses provide protection in practice:

• Certainty when things go wrong: Both parties know exactly what will happen financially in the event of a breach. That predictability helps businesses plan and reduces risk.
  
• Avoiding prolonged disputes: Proving actual losses in court is expensive and time-consuming. A set amount agreed in advance eliminates the need for endless calculations and arguments.
  
• Covering losses that are hard to measure: Some harms, like reputational damage or missed opportunities, don't come with an easy dollar figure. Liquidated damages acknowledge this reality and assign a value to it upfront.
  
• Encouraging compliance: When the financial consequences of a breach are clearly spelled out, it gives the other party a stronger incentive to adhere to their end of the deal.

The benefits extend to both sides of a contract. The non-breaching party gains a guaranteed remedy, while the breaching party avoids the risk of an unpredictable judgment that could be far worse.

With the right language, a liquidated damages clause balances these interests and keeps business relationships on steadier ground.

What Rules Does California Apply to Liquidated Damages?

Knowing the value of liquidated damages is one thing, but you also need to make sure they hold up under California law. Courts in this state scrutinize these clauses closely, so it's worth understanding how they are handled.

California Civil Code Section 1671 sets the standard. For most commercial contracts, the law presumes a liquidated damages clause is valid. If someone wants to challenge it, they must prove it was unreasonable at the time the contract was signed. That puts the burden on the challenger, not the party seeking to enforce the clause.

For a clause to stand, three conditions must be met:

• Damages must be hard to predict: At the time the contract was created, actual losses from a breach had to be uncertain or impractical to measure.
  
• The amount must be reasonable: The agreed sum should reflect a fair forecast of what those losses might be.
  
• It cannot be a penalty: Courts will not enforce numbers that look like punishment rather than compensation.

California also sets special rules for contracts involving consumers or residential real estate. For example, in home sales, liquidated damages are often capped at 3% of the purchase price, and the clause has to be separately initialed to be valid.

Consumer service contracts are even more restrictive, with many provisions automatically void unless the damages are genuinely difficult to calculate.

The takeaway for business owners is that a one-size-fits-all clause won't do. Contracts must be drafted with care, taking into account California's specific requirements. Done correctly, the clause can be a powerful safeguard; done poorly, it risks being thrown out in court.

A poorly written liquidated damages clause risks being invalidated. Consulting with a business litigation attorney is essential to ensure enforceability under California law. 

At Thorsnes Bartolotta McGuire, our attorneys review contracts, advise businesses on enforceable provisions, and represent clients when disputes arise. ‍Contact us at (619) 236-9363 to safeguard your business.

Examples of Liquidated Damages in Business Contracts

Contracts only function well when both parties keep their promises. When one side fails to deliver, a liquidated damages clause sets out in advance what that breach will cost. By agreeing on the number upfront, both sides avoid disputes later about how much money should change hands.

Here are some ways these clauses appear in different industries:

Construction Contracts

• Breach: A contractor fails to complete a new commercial building by the agreed-upon deadline. This is a typical liquidated damages example, since the owner will incur costs such as continued rental of their old facility, lost revenue from the new building, and additional inspection fees.
  
• Liquidated damages: The contract specifies that the contractor must pay the owner $1,500 for each day of delay past the completion date. This figure is a reasonable estimate based on anticipated rental losses and related costs.

Real Estate Transactions

• Breach: A homebuyer defaults on the purchase and walks away from the deal for a reason not covered by the contract. The seller loses time and the opportunity to sell the home to another buyer.
  
• Liquidated damages: The contract contains a clause stating that if the buyer defaults, they will forfeit their earnest money deposit to the seller. In California, this deposit often equals about 3% of the purchase price.

Software Development and Service Agreements

• Breach: A software developer misses the delivery date for a new module promised to a client. The delay disrupts the client's operations and may result in lost revenue, which is difficult to quantify.
  
• Liquidated damages: The contract specifies that for each day the software is late, the developer will credit the customer 0.5% of the license fee, up to a maximum of 30 days.

Employment Agreements and Non-Compete Clauses

• Breach: A former employee violates a non-compete agreement by joining a competitor within the restricted timeframe. The employer suffers harm from the loss of a competitive advantage and potential client poaching, which are hard to calculate.
  
• Liquidated damages: The agreement stipulates that if the employee breaches the clause, they must pay an amount equal to three months' salary.

Commercial Leases

• Breach: A tenant breaches a long-term commercial lease by terminating it early. The landlord loses rent, marketing expenses, and faces the cost of finding a new tenant.
  
• Liquidated damages: The lease may include a "rent acceleration" clause, requiring the tenant to pay the landlord a fixed number of future periodic payments as compensation for terminating the lease early.

What Is the Process for Enforcing Liquidated Damages?

Liquidated damages clauses are powerful tools, but they don't enforce themselves. When one party breaches a contract, the law provides a step-by-step process for determining whether the clause will be enforced and how payment is collected.

1. Demand for payment: The non-breaching party typically initiates the process by sending a written notice that identifies the breach and requests payment under the contract.
   
2. Pushback from the breaching party: The other side may deny a breach occurred or argue the damages amount is too high to be enforceable.
   
3. Alternative dispute resolution (ADR): Many contracts include a requirement for mediation or arbitration before resorting to litigation. These processes provide both parties with an opportunity to resolve their differences without the need for public court proceedings.
   
4. Filing a lawsuit: If the dispute isn't resolved privately, the non-breaching party can file a breach of contract lawsuit to enforce the clause.
   
5. Court review: California judges examine whether the clause was fair when the contract was signed. If the number looks like a penalty, it will likely be thrown out. If it represents a reasonable estimate of potential loss, courts generally uphold it.
   
6. Judgment and collection: When a judge enforces the clause, the decision becomes a binding order. If payment isn't made voluntarily, the winning party may need to use collection tools, such as bank levies or property liens.

Because courts closely examine liquidated damages clauses, the way they are written and applied makes all the difference. That is why businesses often turn to experienced attorneys, both to draft enforceable contracts and to support them when disputes arise.

Why Businesses Turn to Attorneys for Liquidated Damages

Liquidated damages clauses are meant to simplify disputes, but in practice, they often spark arguments over fairness, enforceability, or whether a breach even occurred.

California courts apply strict rules, and without careful preparation, a business could end up with a clause that looks valid on paper but collapses under scrutiny.

That is where a business litigation attorney makes a difference.

• Drafting with enforceability in mind: Attorneys ensure the clause reflects a fair estimate of potential losses, not a penalty. That foresight makes it more likely to hold up if challenged.
  
• Protecting your interests in a dispute: Protecting your interests in a dispute: If you are enforcing a clause, a lawyer can present evidence that supports the reasonableness of the agreed amount. If you are defending against one, counsel can argue that the figure is excessive or unfair, or even raise related claims such as tortious interference when another party disrupts your contractual relationships.‍
• Negotiating when conflict develops: Even when litigation is a possibility, many disputes resolve through negotiation. Attorneys know how to push for settlements that save time and money while protecting business interests.‍
• Managing the courtroom process: From filing the complaint to collecting a judgment, the court system has rules and deadlines that can trip up even seasoned business owners. An attorney keeps the case on track and positions it for success.

For California businesses, the takeaway is clear: liquidated damages can provide powerful protection, but only when the clause is enforceable and backed by vigorous legal advocacy. That combination can mean the difference between securing compensation and losing it.

Thorsnes Bartolotta McGuire Protects Your Businesses

For over 40 years, Thorsnes Bartolotta McGuire has helped businesses in California protect their contracts and recover millions when agreements fail to materialize. Our lawyers understand how disputes over liquidated damages unfold and how to build strategies that protect business interests in and out of court.

Business owners often ask us what are liquidated damages and how they can effectively safeguard their contracts. The answer depends on having clauses that are drafted correctly and enforceable under the law. That's where we come in.

Founded in 1978, our San Diego-based firm has secured over $2 billion in verdicts and settlements. We bring that track record to every client we represent, combining sound legal guidance with the strength needed to protect what you've built.

If you are facing a contract dispute or want to ensure your agreements are drafted to withstand scrutiny, we're here to help. Contact Thorsnes Bartolotta McGuire at (619) 236-9363 or schedule a consultation online with a business litigation attorney today.