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LIQUIDATED DAMAGES AND OTHER AGREED REMEDIES CLAUSES

If a delivery is late and the buyer suffers a loss as a consequence, the buyer is entitled to damages in accordance with the applicable law—unless the contract says otherwise. A buyer who claims damages might first have to expend time and money on litigation, the outcome of which may be difficult to predict. The buyer has to prove its loss and to do everything in its power to mitigate the loss. To avoid unnecessary trouble, agreed remedies such as liquidated damages can offer a better way.

Contracting parties in business-to-business dealings often amend the default rules—in particular the remedial rules— of the sales laws by using liquidated damages clauses in their contracts. Such clauses can be found in individually negotiated terms and in STCs. They are frequently used in connection with delivery and performance guarantees. Here is an example of a liquidated damages clause relating to a delay in delivery:

If the Product is not delivered at the time for delivery, the Purchaser is entitled to liquidated damages from the date on which delivery should have taken place.

The liquidated damages shall be payable at a rate of 0.5 percent of the purchase price for each completed week of delay. The liquidated damages shall not exceed 7.5 percent of the purchase price.

Because liquidated damages clauses vary, you need to be aware of what kind of liquidated damages you are dealing with. Whether a liquidated damages clause limits or adds to the supplier's liability for damages depends on the clause and on the applicable law, which determines how the clause is interpreted in case of a legal dispute. Not all clauses are enforceable as written.

Some contracts contain clauses providing that the buyer is entitled to both liquidated damages and damages for the entire loss it has suffered, while others provide liquidated damages and expressly state that these are the only remedy. The former (which can open the door to consequential loss claims) favor the buyer; the latter favor the supplier. Here is an example of the latter kind:

Liquidated damages (and termination of the contract with limited compensation as stated above) are the only remedies available to the Purchaser in case of delay on the part of the Supplier. All other claims against the Supplier based on such delay shall be excluded, except where the Supplier has been guilty of gross negligence.

So liquidated damages can limit liability and remedies, or can provide for additional liability and remedies. Where the latter is the case, the default rules of the applicable law (invisible terms) have to be taken into account. While it is rather easy to spot a clause mentioning additional or cumulative remedies, it is more difficult to spot the lack of a clause stating that the agreed remedies are exclusive. The lack of such a clause may in fact lead to the same outcome: agreed remedies cumulated with remedies provided by the applicable law. Contract literacy requires that you understand both agreed and invisible terms, as illustrated in Figure 5.2.

Contracting parties generally use liquidated damages clauses to remove uncertainty and avoid litigation costs. However, in some circumstances, courts might still intervene. In some

Applying contract literacy to agreed remedies

Figure 5.2 Applying contract literacy to agreed remedies

legal systems, for instance, the sum stipulated may be reduced by the courts if it is considered excessive or invalidated if the clause is considered a penalty. Common law systems generally distinguish between penalty clauses (which are not permitted) and liquidated damages clauses (which are permitted), the latter being based on a genuine estimate of the loss suffered as a result of the breach. Whether the parties call their clause a penalty or liquidated damages is not decisive. If a stipulated amount is to be paid in addition to the actual loss suffered, it may be considered invalid as a penalty.[1]

To provide clarity, you should state whether the liquidated damages clause excludes or is in addition to other remedies and make sure that you understand its impact. To control risks, your organization needs to have a basic understanding of both contracts (including STCs, where involved) and the applicable laws. they need contract literacy.

Depending on their contents, liquidated damages and other agreed remedies clauses may be pro-supplier or pro-buyer. The following table lists examples of both.

Table 5.2 Examples of agreed remedies, pro-supplier and pro-buyer

Pro-supplier:

  • • Promise only liquidated damages in case of delay in delivery
  • • Promise only to repair or replace if the goods are defective
  • • Agreed remedies specified to be exclusive remedies: no room for default rules/invisible terms.

Pro-buyer:

  • • High liquidated damages payable irrespective of buyer's actual loss
  • • Right to reject goods that fail to conform "in any respect"
  • • Agreed remedies specified to be additional remedies; remedies based on default rules/invisible terms also apply.

When used to specify limitation of liability and remedies, contract clauses can provide protection for a party who breaches the contract. Clauses that contain additional liabilities and remedies protect the innocent party. Both types of clauses are used as contractual tools for allocating risk. Ideally, their content and impact are understood before accepting them. But they do not protect the parties using them from liability to third parties who have not signed the contract. This is where indemnities and hold harmless clauses enter the picture.

  • [1] For the application of liquidated damages clauses and other boilerplate clausesunder English law as opposed to German, French, italian, Danish, Finnish, Norwegian,Swedish, Hungarian, and Russian law, see Cordero-Moss, G. (ed.) (2011) BoilerplateClauses, International Commercial Contracts and the Applicable Law. Cambridge: Cambridgeuniversity Press. the parties will likely choose the governing law of their agreement onthe basis of whether their agreement will be upheld under that law.
 
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