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liquidated damages provision - Exit Promise

When things go wrong with the sale of a business the parties involved look for remedies in the liquidated damages provisions established in the purchase agreement.  Such provisions are included when a purchase agreement has been signed in advance of an actual closing when the business is transferred and a purchase price is paid.

To enforce a liquidated damages provision, the amount to be paid must be appropriate to the amount of damage the breach of contract incurs. This is in contrast to a penalty clause, which is designed to punish a party in breach with a fine that is disproportionate to the actual harm caused. In addition, liquidated damages must cover incidents in which the exact amount of injury would be uncertain or difficult to quantify.

Why Would a Business Seller Want to Have a Liquidated Damage Provision?

Because liquidated damages provisions are agreed upon by both parties when the purchase agreement is created, the seller has some power over determining how much they receive if the buyer breaks the contract. It eliminates the time and money that could be needed for a lengthy court battle to determine a settlement.

Liquidated Damage Provision eliminates the time and money that could be needed for a lengthy court battle to determine a settlement.

Why Would a Business Buyer Want to Have a Liquidated Damage Provision?

Liquidated damages provisions act as a sort of limited insurance for the buyer. If the seller breaches the contract, the buyer knows the exact sum he can expect to receive from the seller to cover his damages. Liquidated damages mitigate the buyer’s losses if the seller fails to meet the terms of the contract.

Examples of Liquidated Damage Provisions in Business Purchase Agreements

A good example of a damage that would be difficult to quantify is a business involving the transfer of property or real estate. If the agreement states that the seller would make the storefront or property available on a certain date, it would be a breach of contract if the seller handed over the property a month late. The exact amount of money the buyer could have made in that time would be difficult to quantify, and so could be written into the purchase agreement as a liquidated damages provision.

If the contract involved a confidentiality agreement or a non-disclosure agreement, publicizing sensitive information could also constitute a breach of contract. The amount of damage the release of a trade secret would cause is again difficult to quantify, and could be addressed in a liquidated damages provision.

As previously stated, liquidated damages provisions are only held up in court if they meet specific requirements. Make sure you talk to your legal counsel when preparing your purchase agreement to ensure such provisions are not in fact penalty clauses.

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Holly Magister, CPA, CFP

Holly A. Magister, CPA, CFP®, is the founder of Enterprise Transitions, LP, an Emerging Business and Exit Planning firm. She helps entrepreneurs assess, re-align, and accelerate their business with the intent of ultimately executing its top-dollar sale.
Holly also founded ExitPromise.com and to date has answered more than 2,000 questions asked by business owners about starting, growing and selling a business.
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