In commercial contracts, liquidated damages clauses provide clarity and certainty when a party breaches the agreement. They pre-define financial consequences (often for delays or non-performance) helping parties avoid disputes over actual loss. But if these clauses impose excessive or punitive amounts, they may be ruled unenforceable by Australian courts.
This article, written by our building and construction law team, explains what liquidated damages are, when they cross the line into unenforceable penalties, and how to draft clauses that courts are likely to uphold.
Key Takeaways
Liquidated damages must reflect a genuine pre-estimate of loss
Penalty clauses are unenforceable under Australian contract law
Courts assess reasonableness at the time of contracting
Clauses must be proportionate and commercially justified
Good drafting = better enforceability and lower risk
What Are Liquidated Damages?
Liquidated damages are pre-agreed sums payable for specific breaches of contract, commonly used in construction contracts, consultancy agreements, and leases.
Their primary benefit is avoiding the need to prove actual loss, which can be costly and uncertain.
For a more detailed explanation of what liquidated damages are and how they work, see our separate guide.
When Are Liquidated Damages Clauses Unenforceable?
A clause will be unenforceable if it amounts to a penalty, rather than a genuine attempt to compensate for loss in the event of a contract breach by a party.
A clause may be found to be a penalty and therefore unenforceable if it:
- Imposes an amount that is extravagant or out of proportion to the likely loss
- Lacks a reasonable basis or commercial justification
- Appears designed to deter breach rather than compensate for it
- Applies the same amount to all breaches, regardless of the actual impact
- Is one-sided or unfair, and could be deemed as an unfair contract term under the Australian Consumer Law (ACL)
Courts focus on whether the amount was a reasonable attempt to estimate likely loss at the time of contracting, not whether it matched actual loss.
Learn more about penalties vs liquidated damages in our article.
Case Law – What Do the Courts Say?
In Bellas v Powers [2023], the court ruled a clause unenforceable where a lender sought over $7.8 million on a $3 million loan default. The default interest rate was more than five times the standard rate. The court found no evidence it reflected the lender’s real losses and ruled the clause a penalty clause.
Contrast that with Growthbuilt Pty Ltd v Modern Touch Marble & Granite Pty Ltd [2021], where a $3,500/day delay clause in a subcontract was upheld. The court found the rate reasonable given the project scale and potential commercial losses.
Key takeaways: Proportionality, commercial logic, and documentation at the time of contract formation are essential for enforceability.
Tips for Drafting Enforceable Clauses
In summary, a liquidated damage clause should align with the agreement’s commercial reality and be backed by a legitimate interest. To ensure that liquidated damages in clauses are enforceable, the below is recommended:
Tip | Description |
Use Real Data and Commercial Forecasts | Base liquidated damages on tangible data like project timelines, financing costs, or delay penalties. This supports the amount as a genuine pre-estimate of loss. |
Avoid Rounded Figures | Avoid arbitrary figures like “$5,000 per day.” Use specific calculations (e.g., overhead per day) to justify the amount. |
Document Rationale During Negotiations | Keep records of how the amount was determined (e.g., internal assessments, correspondence). This helps prove the clause is fair and reasonable. |
Tailor the Clause to the Breach | Match the damages amount to the type and severity of the breach. Use different rates for different breach types where appropriate. |
Ensure the Clause is Not One-Sided or Punitive | Avoid clauses that unfairly punish one party. The amount should reflect actual risk and loss, not act as a deterrent. |
Frequently Asked Questions
What is the difference between liquidated damages and penalties?
Liquidated damages are compensatory, pre-agreed amounts for specific breaches. Penalties are designed to punish and are generally unenforceable.
Can liquidated damages be enforced without actual loss?
Yes. If the clause reflects a reasonable pre-estimate of loss at the time of contracting, courts may enforce it even if actual loss is minimal or nil.
How can I prove that a clause is enforceable?
Keep records of how the amount was calculated, including cost projections, historical data, and contract negotiations.
Are liquidated damages clauses allowed in consumer contracts?
Yes, but they must comply with Australian Consumer Law. If a clause is unfair, causes a significant imbalance between the parties, or is not necessary to protect a legitimate interest, it may be void.
What happens if a clause is unenforceable?
The clause will be struck out, and the non-breaching party must rely on general damages, often more costly and difficult to prove.
