If you are late in paying your utility bill, mortgage or installment on a purchase, you may be charged a late fee. There also may be set fees for the cancellation of orders, insufficient funds in an account or even bank inactivity. In a construction situation, liquidated damages (LDs) can appear in a variety of forms, from a daily or weekly rate for delayed performance or delivery to a lump-sum late charge. The most common type of LD is a per-day assessment for late completion. State or federal law regulates many late fees, but the law regards fees for delays in construction (i.e., LDs) as being in a separate category, which general contract law rules govern.
Why do owners put LDs into contracts? Simply put, because they can. Owners understand delayed completion will probably cost money and cause inconvenience. LDs offer the ability to assess damages against a contractor automatically without a lawsuit. Depending on market conditions, contractors may feel they have to accept this contract parameter.
This imbalance of bargaining position has caused the courts to look closely at the LD clause and ensure it is not a penalty or fine. Because American law does not permit individuals or private entities to levy fines (only legislatures and courts can do that), an LD that is considered a penalty is illegal. How is an enforceable LD different from a penalty? The test is simple: An enforceable LD is a reasonable projected approximation, made at the time of contracting, of what the owner’s damages may be in the event of a delay.
Older court decisions also required the amount of the LD to be based on projected damages, which are difficult to calculate (consider late completion of a road segment or of a bridge repair where an owner’s damages are primarily consequential or incidental). Difficulty of calculation is no longer given serious weight in determining whether the LD is a penalty.
The effect of a “waiver of consequential damages” clause on LDs is a potential complicating factor that the courts have not yet addressed. It is becoming common for such a waiver to be included in the general terms and conditions, and it is standard in American Institute of Architects (AIA) form contracts. The waiver is intended to limit a contractor’s delay claims (e.g., extended home office overhead) as well as the owner’s claims for other consequential damages, such as lost profits. Logically, if the owner has agreed to waive consequential damages, those types of damages should not be used in calculating LDs.
For projects with LD clauses, the issues are well-defined: Did the contractor cause the delay? By how many days? Is the LD amount reasonable? A contractor’s principal defense is that the owner—or an excusable event—caused or contributed to the delay. It is worth noting here that a contractor may have a defense to imposition of LDs based on excusable events—e.g., changes or owner interference—even though the contractor had not asked for time extensions when the event occurred.
Under rules developed by state and federal courts, the owner does not have to incur actual delay damages or delay damages equal to the projected amount of the LD. This result may seem unfair, but it supports the concept that the owner wanted to avoid the difficulty of proving actual damages in the first place.
If there is an offset to this apparent unfairness, it is that LDs put a cap on what the owner can recover for delay. For example, delay in completion of an office building, with all the space pre-leased, may cost the owner lost rent that is many times greater than the per diem LD stipulated in the contract. In this way, the contractor can calculate how much it will pay for late completion versus the cost of acceleration to make up for lost time. In one case, where the LDs were low, the contractor decided not to accelerate and to finish late, as the LDs were less than the cost of making up the lost time.
For subcontractors, LDs may appear as pass-through claims from the general contractor. Where the general contends that the subcontractor caused those delays and those delays were the reason for the owner’s assessment of LDs, the general contractor would want to pass those LDs onto the subcontractor. The general contractor can also add its own actual delay damages or, if the subcontract permits, its own LDs. Thus, the subcontractor could end up paying two sets of LDs.
This result is a matter to consider when you are signing a subcontract. Check to see if there are any LDs in the owner-general contractor agreement.
When you see an LD clause in your contract, you might object in order to eliminate it, or you may sign as is. There are reasons, though, to take a closer look at the LDs and think about revising the clause. The revisions could take various forms based on the type of problems the project may encounter.
Consider these problems and how the LD clause would apply:
1. You are building two identical buildings as part of one project, and there is only one LD clause. You complete the first building on time, but the second one is very late. Can you allocate the LDs between the two buildings?
2. Two-thirds of the way through a project, you are running very late with no hope of meeting the contract completion date. The owner default terminates you, takes three months to find a replacement subcontractor, and the whole job is finished nine months late. When do the LDs stop accumulating?
3. By agreement to LDs as a remedy for delays, has the owner waived its right to terminate you for late completion?
4. You reach substantial completion, but you can’t find the cause of intermittent power outages. Do LDs continue after substantial completion? Can the owner assess actual delay damages after substantial completion?
5. Do LDs continue to accumulate after a default termination? If the contract has been terminated, shouldn’t the requirements of the contract cease to apply? Shouldn’t the LD clause terminate, too?
These problems are all based on actual cases. Answers from the courts are inconsistent or nonexistent. However, with careful consideration, you may be able to control the outcome. The following are some suggestions for your contracts:
1. Where major portions of a project are clearly distinguished (e.g., separate buildings), divide the LDs, and allocate them between the buildings.
2. Insert a cap in your contract on the total value assessable as LDs (e.g., 10 percent of contract value).
3. Negotiate the value of LDs to have them step down as parts of the work are completed.
4. Make it clear that the LDs cover all owner delay damages, including consequential, incidental and special damages.
Of course, the best defense to LDs remains the same: your timely requests for time extensions, whether under the clauses for changes, suspension-of-work, differing conditions or force majeure.