Liquidated Damages

Liquidated damages are the most common form of damages that owners can recover. Construction contracts often specify liquidated damages provisions as a daily amount to be withheld from the contract price for each day of delay to the contract completion date. The primary objective for specifying liquidated damages is to secure the timely performance that the contractor promises, rather than to obtain the specified sum. Because the courts commonly uphold such provisions, the party breaching the contract completion time requirements has an uphill battle to refute liquidated damages without a persuasive argument about the cause of delay.

This blog post discusses the enforceability of liquidated damages, how they are calculated, their relationship to actual delay damages, and prime/subcontractor liquidated damages.

Enforceability
Historically, penal bonds were originally a security device for failure to perform, but a breach of performance often carried consequences far more than the damages incurred. Equity courts intervened to prevent unconscionable consequences, and the law courts soon followed. Today, if the amount specified for liquidated damages is used in terrorem to secure performance, rather than as a reasonable quantifying measure of convenience, or is disproportionate to the value of the performance promised and consideration paid, the liquidated damages provision may be viewed as a penalty and held to be unenforceable. Otherwise, courts most often literally enforce the contract provision if they are convinced of the following:

• The amount specified is a genuine estimate by the parties of the extent of the damages that a breach of the contract completion time requirements will cause.
• The actual damages are impossible or very difficult to accurately quantify.

If the court determines that the specified amount of liquidated damages is a penalty, the contractor or subcontractor is still subject to actual damages. An owner, or a general contractor seeking damages against a subcontractor, should be prepared not only to show how the specified liquidated damages amount was calculated, but also, through its cost records, the extent of the actual damages. If the actual damages are negligible, recovery may be precluded.

Estimating Liquidated Damages
The party specifying liquidated damages should do so with care. A specified amount that is too high may prevent qualified contractors from bidding or cause them to include a high contingency figure in their bids to cover the possibility of delay damages. In such a case, the owner bears the extra cost if the project is not delayed.

Liquidated damages may be estimated as a daily rate for the period of late performance based on one or more of the following:

• Extra maintenance, operational, or utility costs in the continued use of an old or inefficient building or facility
• Maintenance of a new building or facility before its beneficial use
• Extra rental of other buildings because of late completion of the new building
• Interest on investment or borrowed capital of the project
• Costs for extra personnel who are on standby waiting for completion
• Extended supervision, inspection, engineering, construction management, or consultant costs
• Costs of moving into temporary facilities
• Impact costs related to follow on contracts or concurrent contracts affected by delay
• Wage/material cost increases

If a subcontractor delays a general contractor, the general contractor receives damages from the subcontractor to recover the liquidated damages that the general contractor owes the owner.

Actual Damages
A Liquidated Damages clause in a contract is generally deemed to replace actual damages for delay. If there is no Liquidated Damages clause, however, then the contractor may be liable for and the owner may withhold actual damages. The owner can only collect both liquidated and actual damages if the following is true:

1. Liquidated damages are limited to certain specified types of owner damages, such as extended engineering, interest, taxes, etc.
2. The liquidated damages calculation specifically excludes other damages that may occur, such as claims of other contractors affected by the delay.

Likewise, the owner cannot circumvent the Liquidated Damages clause because its actual damages are greater unless such exclusions qualify the liquidated damages.

Prime/Subcontractor Liquidated Damages
If a subcontractor causes delay, the prime contractor may not only have to pay the owner liquidated damages for delay, but also pay additional costs for its own damages, such as extended overhead, field indirect costs, and delay claims of other subcontractors affected by the delay. Because these liquidated damages and other damages are separate and distinct, the prime/subcontractor agreement should specify the prime contractor’s entitlement to collect both types of damages from its subcontractors.

Liquidated damages typically commence on the contract completion date, but certain contracts may include liquidated damages if certain other milestone dates are not met. The number of delay days typically used in calculating liquidated damages is the number of calendar days that extend past the specified liquidated damages date. Courts may rule that liquidated damages stop when Substantial Completion is achieved or when the owner takes beneficial occupancy. To avoid uncertainty, the Liquidated Damages clause should specify whether the delay calculation should use calendar days or exclude weekends and holidays.

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