What do 'liquidated damages' refer to in contracts?

Liquidated damages refer specifically to a predetermined amount of money that parties agree upon in a contract, to be paid if one party fails to fulfill their contractual obligations. This concept is designed to provide a clear and agreed-upon method for addressing breaches of contract, simplifying the process for both parties involved.

By establishing these damages in advance, parties can avoid lengthy disputes about what constitutes a reasonable amount of compensation for a breach, as the figure is set at the contract's inception. Liquidated damages are often used when actual damages may be difficult to calculate or prove. This form of compensation offers greater certainty and security for parties in a contract, facilitating better risk management and planning.

Other options such as compensation for normal wear and tear, general penalties for late payments, or flexible fines based on circumstances do not capture the essence of liquidated damages, which is the pre-agreed nature of the compensation tied specifically to breaches of contract.