particularly attractive to project owners, because the money can
simply be withheld from money owed to the contractor once the
agreed-upon completion date has been passed.
However, like any provision in a contract, a liquidated damages
provision should be the product of negotiation to ensure not
only that it is fair to both parties, but that it is enforceable in the
relevant jurisdiction if a dispute about payment of the liquidated
damages should arise. Disputes regarding liquidated damages
generally arise when the breaching party argues that the provision
is not enforceable, in which case courts will generally consider
several factors in deciding on enforceability: the difficulty in measuring
the kind of losses an owner suffers because of delay and the
reasonableness of the amount of damages in relation to the anticipated
or actual damages suffered. Despite the possibility of a provision
being found unenforceable, when entering into a contract
that contains a liquidated damages clause, a contractor should
presume that it is going to be enforceable.
Liquidated damages must measure losses that are
difficult to prove
Liquidated damages only apply to the exact type of breach specified
in the contract. In its most common form, a provision providing
liquidated damages for delay is an agreed upon substitute for
actual damages an owner might suffer but that could be extremely
difficult, and probably expensive, to prove in court. These can
include many types of damages such as lost financing cost, missed
opportunities or lost rent.
While very real, these types of damages can be difficult to quantify
because questions such as what revenues were lost, the time
period during which revenues were lost and extra costs incurred
or costs avoided will have to be answered. Agreeing to liquidated
damages relieves the owner from being able to prove these types of
damages and may also allow a contractor to factor the cost of the
contract completion date into its bid.
In some states, liquidated damages provisions may not be
enforceable after substantial completion where the owner has
been able to occupy and use the project before the final completion
date, as after this time period, damages are no longer difficult
to calculate.
Liquidated damage must be reasonable in proportion
to anticipated or actual harm
If the liquidated damages do not reflect a reasonable estimate of
the loss incurred due to delay, they may be deemed an unenforceable
penalty, and could be struck down by a court as against public
policy. In short, they should reflect a loss that is based on what an
owner would lose if the project could not be used as intended by
the time promised.
This prevents liquidated damages from being seen as a punishment.
Whatever the amount agreed upon, in the end it must have
been considered reasonable at the time of contracting or bear
some relation to the actual loss, and cannot be merely an arbitrary
number chosen by the owner that it thinks is big enough to
ensure that the job gets done in time. In other words, the rate must
somehow be related to the contract, and not be designed to spur
performance. The downside to this for the contractor is that even
if the owner incurs only nominal administrative charges because of
a delay, the amount of liquidated damages that was properly established
in the contract will still be found reasonable by the courts
because they were based on foreseeable actual damages.
Negotiating liquidated damage provisions
While it is the party challenging the validity of the liquidated
damage provision, usually the contractor, that has the burden of
proving that the provision is unenforceable, if a court were to find
a liquidated damage provision unenforceable, the owner would
then be in the position of having to prove its actual damages. For
this reason, it is in both parties’ best interests to craft a fair and
enforceable liquidated damages provision. So even though these
provisions are primarily designed to protect owners, contractors
should remember that a liquidated damage provision also prevents
them from being exposed to lengthy and expensive court
battles and actual damages, which could easily exceed the agreedupon
amount of liquidated damages. With liquidated damages, at
least a contractor will know what its exposure is, and can take that
into account when negotiating the rate for liquidated damages.
This is especially true if the liquidated damages are capped.
Parties should consider and try to factor in all potential costs
that may be incurred if a project is delayed so that if a dispute arises,
the amount will be considered reasonable. This might include
financing costs past the completion date, additional management
or overhead costs, upstream liquidated damages clauses or prescheduled
uses to which the project has already been committed.
CONSTRUCTION LAW
When entering into a contract
that contains a liquidated
damages clause, a contractor
should presume that it is
going to be enforceable.
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