Final answer:
Liquidated damages are predetermined amounts set in a contract to compensate for losses in case of a breach, providing clarity and easing dispute resolution without court involvement. They must be a reasonable forecast of potential damages, not punitive, to be enforceable.
Step-by-step explanation:
Liquidated damages are specific amounts that contracting parties stipulate within a contract as compensation in the event of a breach. These are agreed upon by the parties during the formation of the contract and are intended to represent a fair estimate of the damages that would occur if the contract is not fulfilled as per its terms.
The use of liquidated damages serves multiple purposes. They provide certainty and clarity regarding the consequences of a breach, facilitating dispute resolution without having to go to court to determine actual damages. This makes them particularly useful in situations where the actual damages might be difficult to calculate. However, for liquidated damages to be enforceable, they must not be punitive in nature; they should be a reasonable forecast of potential damages and not a penalty that exceeds the likely harm caused by the breach.
In the case of a contract breach, if liquidated damages are outlined in the agreement, the non-breaching party can claim the agreed-upon amount. Courts will enforce these provisions as long as they are not considered a penalty and reflect a reasonable attempt to estimate the loss in advance.