This is part one of a two-part blog series informing contractors how they can limit their exposure to owner’s project delay damages, which in many instances may exceed the fee the contractor might otherwise make on the construction project. Part I of this blog series discusses how utilizing well-drafted liquidated damages clauses can protect a contractor from potentially limitless actual damages.
Many contractors view liquidated damages as a “penalty” to ensure timely performance of the contract. They mistakenly believe that it is good practice to remove the liquidated damages clause from a contract. Actually, contractors who remove liquidated damages provisions, reasoning that the liquidated damages clause eliminates the contractor’s exposure to owner damages, are likely increasing their exposure to damages. By eliminating the known and limited liquidated damages clause, the contractor may expose itself to the owner’s actual damages, which are unlimited. In contrast, a well-drafted liquidated damages provision caps the contractor’s exposure to a defined and predictable amount of damages in the event of a project delay.
- 1. Contract Damages
Without a liquidated damages clause, if the contractor breaches the contract, it is legally bound to pay the owner money damages in an amount sufficient to give the owner its “benefit of the bargain;” i.e. the contractor must compensate the owner in the amount to place the owner in as good of a position as if the contractor had fully performed. For a construction project owner, every additional day of construction may carry additional financing costs, extended costs to occupy alternate facilities, lost opportunities to sell the finished project, lost revenues from operation of the project (i.e. rents, retail sales, manufacturing, etc.), decreased funding availability, missed market opportunities, and countless other costs depending on the nature of the project. In the event of a delay, the damages to the owner may very well exceed any fee the contractor hoped to make on the job.
- 2. Liquidated Damages
A liquidated damages provision is an agreement to forgo potential disputes about actual damages in the event of a breach and, instead, agree in advance to a reasonable estimate of the probable damages. In most states, liquidated damages are legally enforceable as long as (1) the amount is a reasonable forecast of the anticipated harm caused by the breach, and (2) the harm is difficult to calculate. A liquidated damages provision, however, will not be upheld if it amounts to a penalty.
- 3. Properly-Drafted Liquidated Damages Clauses
A balanced liquidated damages clause includes the following elements: (1) a clear definition of when liquidated damages apply (i.e. 90 days of the receipt of the notice to proceed, a date certain, etc.); (2) a reasonable amount or rate for the liquidated damages based on the circumstances of the project; (3) a clear indication that the liquidated damages constitute the “sole and exclusive” remedy for performance failure; and (4) typically, a cap on the aggregate liquidated damages amount (for example, the amount of the contractor’s fee or the contract price). For more tips on drafting, read our blog article Top 10 Construction Industry Contract Provisions – Liquidated Damages.
- 4. Benefits of a Liquidated Damages Clause
A liquidated damages provision limits and defines the delay damages as well as the contractor’s exposure to such delay damages. Liquidated damages generally reduce the risk to the contractor by offering certainty and predictability in the event of delay. Such clauses protect the contractor against consequences that may be out of the contractor’s direct control. Courts often struggle with liquidated damages provisions, but the law binds parties to perform in accordance with their contractual undertakings and, thus, generally enforce liquidated damages provisions. A balanced liquidated damages clause imposes a fair estimate of damages anticipated from a delay or breach, and can be an invaluable implement to the contractor to manage risks and streamline potential disputes should they arise.
Part II of this blog series will discuss consequential damages waivers and limitation of liability clauses, which are other contractual provisions that may limit a contractor’s exposure to damages to an owner.