What is the purpose of liquidated damages in a contract?

Liquidated damages serve as a pre-determined amount of money that a party agrees to pay in the event of a breach of contract. The essential purpose is to establish an agreed-upon compensation that reflects the anticipated losses incurred due to the breach. This arrangement allows both parties to have a clear understanding of the financial consequences of non-performance, which helps facilitate smoother negotiations and potentially enhances contract compliance.

By setting a specific amount for liquidated damages at the inception of the contract, the parties aim to avoid the uncertainties and complexities associated with proving actual damages after a breach occurs. This provision provides a measure of predictability and can help avoid disputes over the extent of damages, making it a practical solution for both parties involved.

While other options discuss aspects related to contractual obligations, they do not encompass the fundamental essence of liquidated damages, which is to simplify the recovery process by estimating anticipated losses in advance rather than enforcing punitive measures or entirely eliminating risks.