If not carefully drafted, a liquidated damages clause can invite as much litigation as it eliminates. Consider a typical clause in which the parties stipulate to damages in the event of delayed delivery:
“If Seller breaches its obligation to deliver goods in accordance with the schedule provided for in this contract, Buyer shall have the option to recover $x per day for each day of delay as liquidated damages."
Parties enter into such stipulations to eliminate disputes over the amount of damages, an expensive aspect of litigation often involving significant discovery and the retention of experts.
Although not as well-appreciated, a liquidated damages clause can also eliminate disputes about mitigation. As a general rule, a breaching party cannot seek to reduce or avoid the payment of liquidated damages by claiming that the aggrieved party failed to mitigate; that would undermine the predictability that such clauses are supposed to ensure. See 24 Williston on Contracts §65.31 (4th ed. 2013).
While plainly of value, liquidated damages clauses also serve as a sort of lightning rod for litigation, frequently striking the breaching party as excessive when a default later occurs.
There are four types of challenges commonly raised to such clauses, which give rise to four drafting techniques that should be considered when negotiating the terms of such a liquidated damages provision:
