When a supplier fails to deliver, a customer refuses to pay or a contractor finishes months late, the natural reaction is frustration, and often a wish to make the other party pay for the trouble. Contract law takes a different view. Damages for breach of contract are generally meant to compensate, not to punish. As far as money can, they aim to put the innocent party in the position it would have been in if the contract had been performed.
That principle changes how a business should respond to a breach. The question is not how badly the other party behaved, but what economic position the business has lost, what it can prove and what it has done to keep the loss down. It also changes how a business should set liquidated damages, the agreed amounts payable for delay that appear in many supply and construction contracts. A sound rate comes from what delay would actually cost, not from a percentage borrowed from the last contract.
This article explains, in general terms, how compensation for breach is approached, why the innocent party still has to act sensibly after a breach, and how to set a liquidated damages rate that reflects real delay costs. It is general information, not legal advice. Claims, termination and liquidated damages clauses all carry legal risk, so take advice from a lawyer on significant matters.
Compensation, not punishment
Damages for breach of contract generally come in three forms:
- Unliquidated damages: an amount assessed after the breach, based on the loss proved.
- Liquidated damages: an amount agreed in the contract in advance, usually for delay.
- Nominal damages: a small amount where a breach occurred but no real loss can be shown.
The guiding idea for unliquidated damages is the difference between two positions: where the business would have been if the contract had been performed, and where it actually is after the breach and reasonable efforts to reduce the loss.
Reconstruct the economics
A useful way to assess a breach is to model two worlds side by side:
- The expected world: the financial position if the contract had been performed properly.
- The actual world: the financial position after the breach and the steps taken in response.
The difference is the starting point. Several tests then narrow it down:
- Causation: was each loss actually caused by the breach?
- Remoteness: was the type of loss one that would naturally arise from the breach, or that both parties would reasonably have had in mind as likely when they made the contract? Unusual losses that the other party could not have anticipated may not be recoverable.
- Evidence: can each amount be proved with invoices, records and calculations?
- Avoided costs: what did the business save because the contract was not performed?
- Mitigation: what reasonable steps reduced, or could have reduced, the loss?
For example, if a supplier fails to deliver a machine priced at $400,000 and the buyer has to pay $450,000 for an equivalent machine elsewhere, plus $20,000 for urgent freight, the core of the loss is the extra $70,000, not the full contract price. Whether each amount is recoverable depends on the facts, the contract and the law.
Common mistakes in claims
- Treating damages as a fine. Claims built on anger tend to be inflated and lose credibility.
- Starting from the contract price rather than the change in the business’s position.
- Counting the same loss twice, for example claiming both lost revenue and the costs that revenue would have covered.
- Confusing revenue with profit. Lost sales are not lost profit; the costs saved by not making those sales must be deducted.
- Ignoring costs avoided because the contract was not completed.
- Poor records. Losses that cannot be proved are hard to recover.
A simple loss register, started as soon as a significant breach occurs, records each cost or loss, its cause, the evidence and the date. Involving whoever handles the business’s finances early stops claims being reconstructed months later from incomplete records.
The innocent party still has decisions to make
Being the innocent party does not give a business permission to let losses grow. The law generally expects the injured party to take reasonable steps to reduce its loss, and a business usually cannot recover losses caused by an unreasonable failure to do so. This is called mitigation.
Mitigation is not surrender. Buying replacement goods, accepting substitute work or hiring temporary capacity does not excuse the breach. It reduces the loss, and the business can still claim the reasonable extra cost.
Consider a supplier that fails to deliver material priced at $100 a unit. Equivalent material is available immediately for $110. If the buyer declines it, waits and later makes an emergency purchase at $160, it may struggle to recover the extra $50 a unit, because a reasonable business would have taken the $110 option.
After a breach, assess quickly:
- Alternatives: what substitute supply, work or capacity exists?
- Cost: what will mitigation cost?
- Risk: does the alternative create new quality or operational problems?
- Timing: how soon must you act?
- Records: what options did you consider, and why did you choose as you did?
Keep a mitigation log of these decisions. It shows that the business acted reasonably on the information available at the time, even if a different choice looks better in hindsight. At the same time, send any notices the contract requires and reserve your rights in writing, so that acting quickly to protect the business does not obscure the link between the breach and the cost.
The best mitigation is often prepared before any breach: knowing alternative suppliers, replacement lead times and workarounds for critical goods and services.
Liquidated damages: an agreed price for delay
Many contracts for equipment, construction and services include liquidated damages: an agreed amount per day or week payable if the work is late. They save the cost of proving actual loss after the event and give both parties certainty about the consequence of delay.
In Australia, a clause that imposes an amount out of all proportion to the legitimate interests it protects may be unenforceable as a penalty. A rate grounded in a genuine attempt to estimate the likely cost of delay is far easier to defend. Liquidated damages clauses can also limit what can be claimed for delay, so the rate matters in both directions. Take advice on how the clause is drafted.
Set the rate from what the asset is for
The right rate depends less on the size of the contract than on what the finished work is meant to do for the business. Research by Ma and Lam on liquidated damages in construction distinguished different kinds of assets, and the general lesson holds: the cost of delay follows the purpose of the asset.
| Asset purpose | How delay costs money |
|---|---|
| Rental property | Lost rent, adjusted for realistic occupancy |
| Property for sale | Delayed settlements and extra finance costs |
| Production equipment | Lost contribution from output, temporary outsourcing, overtime, customer impact |
| Fit-out or premises | Extended rent elsewhere, delayed trading, temporary arrangements |
| Non-commercial or community asset | Extended project costs and temporary services, rather than lost revenue |
A practical approach:
- Identify the benefit that begins when the work is complete.
- Estimate how delay interrupts it, day by day or week by week.
- Consider realistic alternatives: inventory, temporary premises, subcontracting.
- Add extended costs: project staff, storage, temporary arrangements.
- Allow for ramp-up: new equipment rarely runs at full output on day one.
- Avoid double counting and check the result against several scenarios.
- Record the reasoning before the contract is issued.
The what is a day worth article describes how to calculate the cost of delay for decisions more generally.
Legal strength is not the same as the best response
Even when a claim is strong, the best commercial response is not always to pursue it in full. Consider the relationship, the cost of a dispute, management time, the effect on future work and whether a negotiated outcome would deliver more value. A strong legal position gives a business options. It does not decide which option is best.
A worked example
This is an illustration. A bakery orders a new production line for $400,000 to supply a supermarket contract starting on 1 March. Before issuing the contract, the owner works out a liquidated damages rate rather than using the supplier’s suggested figure of 0.5% of the contract price per day, which would be $2,000 a day.
The supermarket contract is expected to earn a contribution of about $2,400 a day once the line is at full output. But the owner identifies a realistic alternative: a co-packer could produce the product for the first few weeks at an extra cost of about $1,100 a day, preserving the supermarket contract. Delay would also mean extra costs for storage and the project staff of about $300 a day. The realistic cost of delay is therefore about $1,400 a day, not the full $2,400, because the business would use the co-packer rather than lose the contract. The owner sets the rate at $1,400 a day and records the calculation with the tender documents.
The line is delivered 12 days late. The bakery uses the co-packer, as planned, keeps the supermarket supplied and claims liquidated damages of 12 × $1,400 = $16,800. Because the rate is clearly based on a genuine estimate and matches what the business actually experienced, the supplier accepts it without dispute.
The owner also keeps a mitigation log showing the co-packer arrangement, its cost and the notices sent to the supplier. Had the business instead refused to use the co-packer and lost the supermarket contract, it would have faced difficult questions about whether it had acted reasonably to limit its loss.
How this applies to a small Australian business
Small businesses often respond to breaches emotionally and set liquidated damages by habit. Practical steps:
- Frame claims around the lost position, not punishment.
- Start a loss register as soon as a significant breach occurs.
- Separate revenue from profit, and deduct avoided costs.
- Act promptly to reduce the loss, and keep a mitigation log.
- Send required notices and reserve rights in writing.
- Set liquidated damages from the asset’s purpose, with realistic alternatives and ramp-up.
- Record how the rate was calculated before the contract is signed.
- Weigh commercial consequences alongside legal strength.
- Seek dispute support from your state small business commissioner or the Australian Small Business and Family Enterprise Ombudsman, and legal advice for significant matters.
The how contracts end article covers termination and controlled exits.
Signals worth watching
- Claims driven by anger rather than evidence.
- Loss schedules without invoices or calculations.
- Lost revenue claimed in full without deducting saved costs.
- Teams waiting for a legal strategy before protecting operations.
- The same liquidated damages rate used for very different projects.
- Rates set as a percentage of contract value with no link to actual delay cost.
Common mistakes
- Trying to punish instead of compensate.
- Letting losses grow to strengthen a claim.
- Double counting different kinds of loss.
- Poor records of costs and decisions.
- Borrowing a liquidated damages rate from another project.
- Assuming a strong claim must be pursued in full.
Frequently asked questions
Can we claim for our time spent dealing with a breach? Sometimes, if the time can be shown to have been caused by the breach and has a real cost. Keep records of time spent and what it was spent on.
Does mitigating mean we accept the breach? No. Reasonable mitigation reduces the loss; it does not excuse the breach or waive your rights. Reserve your rights in writing.
Are liquidated damages the only remedy for delay? Often the contract makes them the remedy for delay, but this depends on the wording. Read the clause carefully and take advice.
What if the supplier says our liquidated damages rate is a penalty? A rate based on a documented, genuine estimate of likely delay costs is much easier to defend. This is why recording the calculation before the contract is signed matters.
Should we always pursue a strong claim? Not necessarily. Consider cost, time, relationships and alternatives such as negotiation or mediation. Use the strength of your position to reach a good outcome, not automatically to litigate.
How quickly should we tell the other party about a breach? Promptly, and in the way the contract requires. Many contracts set notice periods for claims, delays and defects, and missing them can limit what you can recover. A clear, factual notice that reserves your rights is usually better than a heated email.
Questions to ask
- What financial position would proper performance have produced?
- Which losses were actually caused by the breach, and what evidence supports them?
- What costs were avoided because the contract was not completed?
- What can we do today to reduce the loss?
- What does a day of delay really cost on this project, and why?
- Are we seeking compensation or trying to punish?
Bringing it together
Damages compensate a lost bargain; they do not punish. Reconstruct what the breach actually cost by comparing the expected and actual positions, prove each amount, deduct what was saved and act promptly and reasonably to limit the loss. Set liquidated damages from what the finished work is for, allowing for realistic alternatives and ramp-up, and record the reasoning before signing. The strongest claim is not the biggest number. It is the clearest, best-evidenced account of what the breach really cost.
Source: KEVOS notes, drawing on teaching material on contractual remedies, damages and mitigation, and on T. Ma and P. Lam’s 1999 research on assessing liquidated damages for different types of project. Examples and figures in this article are illustrations. This article is general information, not legal advice.
