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What do I need to know about a liquidated damages clause?

Regular visitors to our site may be familiar with our "Best of the Hotline" feature. This is a section where we highlight topics that are on the minds of individuals around the state. If you have a real estate-related question, you might want to check it out.

In one recent offering from this area, we touched on what can be a common issue – a misunderstanding on the part of Pennsylvania home sellers about the meaning of the liquidated damages clause in agreements signed with listing real estate agents. Our hope with this post is to try to take a closer look at what this legal term means and what its implications can be.

Think of it as "performance insurance"

First, it may be useful to explain that a liquidated damages clause is quite common in nearly any contract into which you enter. Typically, the clause sets a maximum amount of money that one party will pay to the other in the event it is determined that there has been some breach of contract.

The purpose of the clause is not to punish breaches. Instead, it serves as protection against possible loss. As such, the amount established is supposed to reasonably estimate actual damages if a breach occurs. In essence, it's a form of insurance that both sides agree to, bringing a level of cost predictability to a transaction for service.

State laws in this regard can differ which is why it's always important to consult with an experienced attorney, but generally, in order for a liquidated damages clause to be enforceable the following circumstances are required:

  • The claimed breach must have caused a loss that is "difficult to quantify" or prove
  • The amount called for is reasonable to cover actual or anticipated harm
  • No other alternative remedy exists, and
  • The intent is to cover damages, not penalize

The presence of a liquidation damages clause does not guarantee a legal dispute won't arise. And when disagreements do develop, it may be useful to know that resolution does not necessarily require going to court. When you look into it, you may find that alternative dispute resolution methods may achieve the desired outcome more quickly and at lower cost than litigation.

Source: FindLaw, "What Are Liquidated Damages?," by Aditi Mukherji, JD, accessed Oct. 20, 2017

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