Parties may agree in advance on the damages payable for breach. Courts enforce such a clause as liquidated damages, or strike it as a penalty, and the line has consumed a great deal of litigation.

The traditional test asks whether actual damages were difficult to estimate at contracting, and whether the stipulated sum was a reasonable forecast of the probable loss. A number set to frighten a party into performing is a penalty and is void.

When measured. Most courts assess reasonableness as of contract formation. Some also look at the actual loss, refusing enforcement where the stipulated sum turns out grossly disproportionate. Knowing which approach the forum takes matters before drafting.

Drafting that helps. A short recital explaining why loss would be hard to quantify. A figure that scales with the seriousness of the breach rather than a single sum for any default. Avoidance of the word penalty. Mutuality where the deal permits.

Drafting that hurts. One flat amount payable for breaches of wildly different magnitude — the classic signal of a penalty. A clause reserving both liquidated damages and all actual damages, which shows the number was never a substitute for proof.

Where they are most useful. Delay in construction, confidentiality breaches, non-solicitation, and deposit forfeitures — situations where real loss is certain but its measurement is genuinely speculative.