In many M&A agreements, the “liquidated damages provision” is employed to create a sort of insurance for both parties involved. With this provision, a specific sum is agreed upon and then imparted to an injured party should the other party breach an obligation listed in the contract.
Damages by the offending party will be liquidated up to the amount of the losses created. Without this provision, it would be up to the party who was harmed in the process to prove the extent that the breach has harmed them financially. In most instances, it can be nearly impossible to ascertain the amount in damages.
The purpose of the liquidated damages provision is to set an agreed-upon amount that must be paid if one party breaches the contract. It is meant to protect liabilities that are otherwise difficult to quantify. It helps both parties avoid the time and expenses of going to court, since the sum is already agreed upon and the damages are considered to be “at large”, negating the necessity for the court. This provision helps parties avoid unexpected litigation.
The liquidated damages provision protects the buyer from being negatively affected by the seller’s conducting of the business for the duration of the M&A process, such as failing to provide a key component or making it difficult to sell a certain product line due to calculated actions. The provision also protects the seller if the buyer defaults.
The liquidated damages provision is also meant to help protect sellers from the buyer backing out of a deal without a valid reason, since this can be considered a damage covered under the provision. Failing to follow through as agreed upon will cost the buyer, and therefore encourage them to complete the transaction.
Another reason that this provision can be beneficial is because it forces both parties to consider the potential for the liabilities of the process. Should a breach occur, it can have colossal damage to the business in question. Therefore, confidentiality should become of serious importance.
One of the negatives of including a liquid damages provision is that the negotiation can slow down the M&A process. However, it is advisable to include the provision to be utilized as a type of insurance for both parties.
The liquidated damages provision only covers damages that are difficult to valuate. If the damages do not fall within this category, the courts can overturn the provisions use for specific instances.
If you are interested in learning more about how to buy or sell a business, please contact us at George & Company. We would be happy to speak with you in complete confidence.