Liquidated Damages
A contractual provision specifying the amount of damages payable on breach, fixed in advance by the parties' agreement. Replaces common-law actual-damages calculation with a predetermined amount, providing certainty and avoiding the cost of proving actual damages.
A liquidated damages clause is a contractual provision specifying the amount of damages payable on breach, fixed in advance by the parties' agreement. Liquidated damages clauses replace common-law actual-damages calculation with a predetermined amount, providing certainty and avoiding the cost and difficulty of proving actual damages.
Validity test (Phillips two-part test)
A liquidated damages clause is enforceable in Texas only if (1) the harm caused by the breach is incapable or difficult of estimation at the time of contract; and (2) the amount of liquidated damages is a reasonable forecast of just compensation. If either prong fails, the clause is an unenforceable "penalty" rather than valid liquidated damages.
Distinction from penalty
Texas courts disfavor penalty clauses, provisions designed to punish breach rather than compensate the non-breaching party. A provision that is not a reasonable forecast of just compensation is a penalty. Under Phillips and FPL Energy, LLC v. TXU Portfolio Management Co., 426 S.W.3d 59 (Tex. 2014), a provision may also fail where actual damages turn out to be much less than the amount contracted for, and the party asserting the penalty may have to prove actual damages to show it. Enforceability is a question of law for the court.
UCC sales (§ 2.718)
UCC Article 2 states a related but distinct test: liquidated damages must be reasonable in light of (1) the anticipated or actual harm caused by the breach; (2) the difficulties of proof of loss; and (3) the inconvenience or non-feasibility of otherwise obtaining an adequate remedy. Unreasonably large amounts are void as a penalty.
Liquidated damages provisions are common in construction contracts (delay damages), real estate (earnest money), employment (training repayment), and intellectual property licenses. Drafting failures involve setting amounts that bear no realistic relationship to anticipated harm. Some contracts recite the parties' difficulty estimating actual damages and the reasonableness of the liquidated amount, though enforceability remains a question of law for the court.
Companion article: Contract Disputes in Texas
Practice guide: Breach of Contract in Texas