Under what circumstance will courts typically allow liquidated damages?

Courts typically uphold liquidated damages when the amount specified in the contract is deemed a genuine pre-estimate of the actual damages that may be incurred in the event of a breach. This principle arises from the understanding that parties may find it difficult to ascertain the exact amount of future damages at the time of contract formation. As such, if the parties have reasonably considered the potential harm that could result from non-performance and have agreed on a specific sum that reflects a fair estimate of those damages, the court is more likely to enforce that provision.

The key condition for the enforceability of liquidated damages is that they are not punitive in nature; rather, they should be compensatory, aimed at providing a fair reflection of the anticipated loss. If the amount set forth is excessively high or disproportionate to the actual harm that would be caused by a breach, courts may classify it as a penalty and therefore unenforceable. This ensures that damages remain within a reasonable range and provides some predictability for both parties in the event of a breach.

The focus on a genuine pre-estimate underscores the parties' ability to assess and agree on risks at the outset of their contractual relationship, which contributes to the overall integrity of contract law.