Welcome back to the informal series on commonly disputed legal clauses (from a procurement perspective). Today, Jeanette Nyden returns to talk about liquidated damages. Jeanette will help us bridge the legal world and the commercial world. Liquidated damages are more on the commercial side of legal language. What are liquidated damages? How does the clause work? How do you calculate the value of liquidated damages? Listen to this episode for the need-to-know details.
NOTE: This is NOT legal advice. For adequate legal advice, please seek out adequate legal counsel—inside or outside your organization.
Outline of This Episode
- [2:00] Learn more about Jeanette Nyden
- [3:40] What are liquidated damages?
- [8:00] Calculating the value of the liquidated damage
- [15:47] Assessing liquidated damages in the SaaS space
- [21:14] Liquidated damages versus consequential damages
- [23:16] Contract professionals make note
- [24:54] Connect with Jeanette Nyden
What are liquidated damages?
Liquidated Damages: Liquidated damages are not a penalty; It is money that a customer receives from a supplier for a value not received.
Sounds confusing, right? Many commercial people believe that liquidated damages are punitive measures that can be placed on someone. They are, in a way. Liquidated damages, from a legal standpoint, cannot be penalties. They are written in a way that conforms with state law, so they’re enforceable (the legal part). But commercially speaking, lawyers have no clue what the risk profile is (i.e., the value anticipated to be received).
If that value isn’t received, then legitimately, what agreement do the parties come to about the cost to reimburse the customer? The risk profile determines the value. The liquidated damages conversation determines what happens when the value is not received.
Why you need to determine the risk profile
Imagine that Jeanette is a customer and I’m a supplier. I’m manufacturing custom machinery. Only three people in the world can manufacture these parts, and Jeanette chooses me. I’m provided with the drawings and the specifications, develop drawings, and make them. But I’m late delivering the product. Value was not received. At contract negotiations, Jeanette should already have negotiated what the cost to the customer would be in this circumstance.
Jeanette works to support public utilities. Many have cordoned-off areas that only people with special clearance can enter. But an employee in a hurry cut through the area, which is a security violation. Security cameras catch the act. There should be liquidated damages to address that security violation because it forces reporting (and costs associated with that). It compensates them for the loss of time and fees that must be paid to governmental agencies and forces the company to properly brief their employees and adhere to safety policies.
Calculating the value of the liquidated damage(s)
People struggle to calculate the value of the potential liquidated damages. What do you ask for? What is it actually worth?
If you don’t have a good risk analysis or cost analysts on the customer side, then you use formulas. Some contracts have safety and security liquidated damages that are formulaic based on company policy. You could calculate that for the first security violation, someone would be dinged $50,000. For the second violation, they’d be cited $100,000. The third time would be a breach of contract for security violations. You can build in an escalation of liquidated damages. Liquidated damages fail their purpose if there are repeated violations.
Jeanette emphasizes that “Without a risk profile and without cost accounting, they’re (liquidated damages) very difficult to establish with accuracy.”
So how do you calculate the value of the liquidated damage(s)? How do you assess liquidated damages in the SaaS space? Listen to the whole episode for more contract negotiation expertise from Jeanette Nyden.
Connect with Jeanette Nyden
- Jeanette’s Website
- “The Contract Professional’s Playbook” – Jeanette is the author
- Follow on Twitter
- Connect on LinkedIn
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