What are liquidated damages in a contract?

Liquidated damages are a specific provision within a contract that defines a predetermined amount one party must pay to the other in the event of a breach. This predetermined sum is agreed upon during the creation of the contract, providing clarity and certainty for both parties involved. The purpose of liquidated damages is to estimate in advance the potential losses that could result from a breach of contract, allowing both parties to avoid lengthy litigation over actual damages.

In the context of real estate transactions, liquidated damages often serve to protect the seller’s interests. For instance, if a buyer fails to fulfill their obligations under the contract, the seller can retain the agreed-upon liquidated damages as compensation, which simplifies the enforcement of the contract.

While other options mention important aspects of contracts and real estate processes, none accurately pinpoint the essence of liquidated damages. A fund for future improvements or costs incurred during closing do not relate specifically to breach scenarios. Similarly, penalties for late payments are distinct from the concept of liquidated damages, which are not meant as punitive measures but rather as a pre-agreed arrangement regarding potential breaches.