Difference Between Liquidated And Unliquidated Damages

Introduction

In the Salic Code, the Saxons had a system called Weregild, which put a price on every person and piece of property. If someone was hurt, killed, or had their property stolen, the person responsible had to pay Weregild to the victim's family or the property owner. This idea led to the concept of damages.

When a court awards damages for a breach of contract, it usually aims to put the injured party back in the financial position they expected if the contract had been followed. Sometimes, parties in a contract agree on a reasonable amount to be paid if the contract is violated. These agreed amounts are called liquidated damages. On the other hand, unliquidated damages are amounts decided by the court based on the actual loss or injury suffered due to the contract breach.

What Are Damages?

Damages are payments given to someone for a violation, loss, or injury. They can protect "expectation interest" (what you expected to get), "reliance interest" (what you relied on), or "restitution interest" (what you deserve back).

Damages are very important, especially in business deals and as punishment for violating someone's rights. The types of damages given can be very different depending on the place. They are often given in cases of harm or breaking a contract.

What Are Liquidated Damages?

When the parties to a contract agree to pay a specific sum and one of the parties fails to perform the contract, the damages are known as liquidated damages. These damages are agreed upon by the parties involved at the time they enter into the contract, i.e., before it is executed. Furthermore, this amount is fixed and cannot be changed once it has been signed.

Section 74 of the Indian Contracts Act of 1872 governs liquidated damages. If a party to a contract breaches it, the other party is eligible for appropriate compensation for the loss experienced by that party. It is important to highlight that the compensation must be a genuine estimate of the loss.

Advantages

The advantages of Liquidated damages are:

Certainty

Liquidated damages give both parties assurance about the implications of a breach. They specify the amount that will be payable in the event of a breach, removing ambiguities and potential arguments over damages.

Time and Cost Efficiency

By deciding damages in advance, parties can avoid the time and expense of contesting the level of damages in the case of a breach. This can help to simplify dispute resolution processes and save legal fees.

Incentive for Performance

Parties might be more careful and quick to fulfil their contract duties if they know they will have to pay liquidated damages for not doing so. Knowing the consequences in advance can help ensure they follow the contract.

Risk Allocation

Liquidated damages enable parties to allocate better the risks associated with a breach. Parties can agree on an acceptable amount of damages up front, taking into account the potential harm caused by a violation, and then share this risk among themselves.

Disadvantages

The disadvantages of Liquidated damages are:

Potential Overcompensation

There is a possibility that the preset sum of liquidated damages may not adequately reflect the actual loss caused by the breach. In some situations, the sum indicated in the clause may be excessive, resulting in overcompensation to the non-breaching party.

Unenforceability

Courts might not enforce liquidated damages clauses if they see them as punishments instead of fair estimates of harm. If the set amount is too high or unfair, courts can cancel the clause, leaving the parties without a clear solution for a breach.

Lack of Flexibility

Once the amount of liquidated damages has been agreed upon and included in the contract, it cannot be easily altered, even if circumstances change. This lack of flexibility may result in unfair decisions if the predetermined amount no longer accurately represents the actual harm caused by a violation.

Incentive for Breach

In some situations, parties may see liquidated damages as a cost of doing business and purposefully breach the contract, knowing they can pay the fixed amount rather than fulfil their responsibilities. This reduces the clause's ability to prevent breaches.

What Are Unliquidated Damages?

Unliquidated Damages are damages resulting from a party's violation that is not quantified in advance. Damages claimed for unexpected losses are not liquidated. Such damages are applicable to any violation of a contract that does not include a liquidated damages clause. However, because the amount isn't pre-determined, figuring out how much compensation the plaintiff should get can be difficult. The court or arbitration tribunals decide these damages based on the actual loss or injury the plaintiff suffered from the breach.

Unliquidated damages require evaluating the damage. The goal is to put the plaintiff in the same financial position as if the contract hadn't been broken. These damages are based on the actual loss or harm suffered by the injured party.

Types

1. Substantial Damages

These damages are an attempt by the court to reflect the innocent party's true loss.

2. Nominal Damages

The plaintiff is given a small amount of money for winning the lawsuit. The court decided that giving them a large sum was not fair. So, this small amount is just symbolic.

3. Exemplary Damages

These damages demonstrate the court's disapproval. As a result, the innocent party receives a huge compensation. Furthermore, the court does not often award exemplary damages. By imposing such damages, the court strives to repair the situation and return the aggrieved party to the position he held before the breach of contract.

Advantages

The advantages of unliquidated damages are:

Flexibility

Unliquidated damages offer greater flexibility in calculating damages since they can be adapted to the unique circumstances of each case. This flexibility allows courts to consider a variety of criteria, including the scope of the breach and the actual losses suffered by the aggrieved party.

Fairness

Unliquidated damages are based on actual losses, making them often seen as more fair and just than liquidated damages, which are set in advance and might not accurately reflect the real harm caused by breaking the contract.

Promotes Settlement

The uncertainty associated with unliquidated damages can persuade parties to resolve disputes outside of court. Knowing that damages would be calculated based on actual losses may encourage parties to compromise and reach a mutually agreeable settlement.

Encourages Diligent Consideration

Parties in a contract might work harder to be clear and detailed during negotiations to avoid confusion and disputes. This can lead to contracts that clearly show what everyone intends and expects.

Disadvantages

The disadvantages of unliquidated damages are:

Uncertainty

The uncertainty surrounding unliquidated damages makes it difficult for parties to identify what they might be responsible for in the event of a breach. Parties may face uncertainty and danger while pursuing legal action or fighting against claims for unliquidated damages since the amount of damages is not defined.

Time-consuming and Expensive

Determining unliquidated damages frequently requires significant evidence and legal actions, which can be time-consuming and expensive for all parties concerned. Litigation or arbitration to assess damages may incur additional costs and delay in settling issues.

Difficulty In Calculation

When assessing unliquidated damages, courts or arbitrators must consider complex issues such as lost profits, increased expenses, and other consequential losses. Calculating these losses accurately can be difficult and may require subjective decisions by the decision-maker.

Disputes

Due to the subjective nature of establishing unliquidated damages, parties may disagree on the proper amount of damages to award. Parties may have different interpretations of the facts and applicable legal principles, resulting in lengthy litigation or arbitration proceedings.

Key Differences

• Liquidated Damages are the predetermined amount agreed upon by the parties when they entered into the contract. In contrast, unliquidated damages refer to the compensation ordered by the court to be paid to the aggrieved party by the defaulting party for the actual loss experienced as a result of the breach of contract.
• Unliquidated damages are not predefined, so the court awards cash equal to the damage. Conversely, liquidated damages are predefined. This signifies that the parties agreed on the compensation when they entered into the contract. Such damages are determined by the parties ahead of the breach.
• Liquidated damages are defined in Section 74 of the Indian Contract Act of 1872. Unliquidated damages, on the other hand, are defined in Section 73 of the Indian Contract Act of 1872.
• Liquidated damages do not need the plaintiff to provide proof of loss. In contrast, proof of loss is required in the event of unliquidated damages.
• After a specific breach, the contract's innocent party may be eligible for liquidated damages. In contrast, the injured party has the right to demand unliquidated damages for unexpected loss or injury.

Comparison Chart

Conclusion

Liquidated damages are awarded when the damaged party can sue the party who violated the contract for a particular amount of money. Furthermore, the sum must be a realistic and reasonable estimation of the actual loss caused by the breach of contract. Unliquidated damages, on the other hand, are awarded when the parties concerned are unable to agree on a sum, and the court has the jurisdiction to decide how much compensation should be given.