Procurement professionals should consider including remedies into their solicitation documents if there is a contract breach. While contract termination is an effective remedy, it may not be appropriate in all circumstances.
For example, an agency may determine that the most suitable remedy for excessive unscheduled downtime is to impose liquidated damages that require the Awarded Vendor to compensate the agency for the contract breach by paying a predetermined amount for each hour beyond the allotted unscheduled downtime.
Many agencies use liquidated damages to motivate the other party to perform and establish conditions for a breach of contract. In this way, liquidated damages act as a strategy for monitoring vendor performance and ensuring timely completion of all contract deliverables that have been identified as most important to the agency.
Click Procurement Examples for system shall statements.
What are liquidated damages?
The Business Dictionary defines liquidated damages as the “sum of money (agreed-to and written into a contract) specified as the total amount of compensation an aggrieved party should get, if the other party breaches certain part(s) of the contract. The contract also establishes what actions or failures to act constitute a breach.
For the agreement to be legally enforceable, the nature of the contract should be such that it is difficult to determine actual damages, and the amount of damages should be reasonable under the circumstances. Otherwise law may regard the specified amount as a fine (included in the contract primarily to force its proper performance) and not a compensation for injury.”
Liquidated damages represent the projected financial loss and expenditures that may occur as a result of Awarded Vendor’s non-performance, including financial loss as a result of delays.
When to use?
Use liquidated damages provisions in your contracts to prevent disputes and encourage contract compliance.
Liquidated damages clause considerations
When writing a liquidated damages clause, think of specific situations that would cause your agency harm if the Awarded Vendor fails to fulfill its obligations under the contract. Examples include:
- Failure to meet implementation milestones
- Extensive system downtime outside of scheduled maintenance period
As seen in the example below, many agencies implementing a new system organize liquidated damages into two categories: prior to go-live and after go-live.
Here’s an example to consider for your procurement document:
Prior to Go-Live
Failure of Awarded Vendor to submit deliverables as agreed to in the approved Project Schedule will result in an assessment of $1,000 per calendar day after the scheduled due date up to 100% of the deliverable amount. The cure period will be one (1) calendar day following the due date.
Unavailability of the solution to agency, outside the normal maintenance period, for more than three (3) hours, after a one (1) hour cure period, will result in an assessment of $4,000 per calendar day.
What is a cure period?
You will see that liquidated damage clauses include a “cure period.”
If a default occurs, the Agency will notify the Awarded Vendor in writing of the default and include liquidated damages that must be paid by the Awarded Vendor.
The “cure period” is the amount of time the Awarded Vendor has to cure the default. Liquidated damages will not be assessed during the specified cure period.
Corrective action plan
The party that breached will have a predefined number of days to submit a corrective action plan for curing the breach.
Here’s a corrective action plan example:
Upon receipt of written notice of any default specified herein, the Awarded Vendor will have ten (10) calendar days to provide a written explanation of any justification that may be applicable to the liquidated damages being considered and a corrective action plan for bringing the operations within the standards specified. Agency will have the right to approve and make changes to the corrective action plan submitted by the Awarded Vendor.
The corrective action plan must be implemented by the Awarded Vendor at no cost to and upon approval by the Agency Contract Manager. Liquidated damages will not be assessed during the specified cure period for the activity in question. The Awarded Vendor’s failure to pay the assessed liquidated damages within the designated time frame may be deemed by Agency as a breach of Contract.
In order to be enforceable, the following conditions are required:
- Difficult to determine – Liquidated damages should be either uncertain or difficult to quantify at the time of contract formation
- Reasonable – Liquidated damages should be a reasonable estimate, proportional to the actual harm incurred, of any potential injury that would be incurred due to a contract breach
- Not a penalty – Liquidated damages should be structured in a manner that does not punish the party that breaches the contract
Be sure to seek the assistance of your agency’s legal counsel when developing liquidated damages to ensure they are well written and enforceable.
How are liquidated damages different from a penalty?
A penalty is a punishment imposed on a party for an infraction or breach of a performance condition in a contract.
Courts will not enforce a liquidated damage provision if it is designed to punish the party that breaches the contract by awarding damages far greater than those actually suffered.
How are liquidated damages different from actual damages?
Actual damages are a financial amount payable to a party that suffered a loss. They are real damages that can be measured and proven including business losses and legal fees. Actual damages are also know as real or compensatory damages. Actual damages arise from an act or failure to act by another party.
Liquidated damages are useful when actual damages are difficult to calculate.
How are liquidated damages different from incentives and disincentives?
Incentive clauses are designed to award payments to a contractor if they complete work ahead of schedule. Similarly, disincentive clauses deduct payments if a contractor completes work behind schedule.
Liquidated damages are compensation due to a breach of the contract.