One of the risks that construction project management look out for is delays. Since the pandemic in 2020, project delays and late completion have been on the rise. According to nPlan, the median delay for projects before the pandemic was 100 days, and that has since doubled to 200 days. Delays can lead to increased costs for project owners in the form of lost revenue, added storage costs, and additional loan interest expense.
Many owners use liquidated damages clauses in their contracts to recoup these potential losses. They’re meant to reimburse owners these costs when the delay is not their fault. Contractors need to understand what liquidated damages are, how they work, and how to avoid them.
What are liquidated damages?
Many construction project contracts contain a clause called liquidated damages. The clause states that if the contractor breaches the contract, usually through a schedule delay, the owner is entitled to payment from the contractor for lost income or increased operational costs caused by the unexcused delay. The penalty clause also states how much the contractor will pay the owner for each day of delay.
Legally, liquidated damages are meant to be used in situations when actual damages are difficult to value. For example, if a store opening is delayed and the damages would include lost profits for a day. It is hard to determine exactly how much those profits would be. The contract clause quantifies those damages ahead of time, allowing both parties to agree to the amount when they sign the contract.
For example, the liquidated damages clause from the ConsensusDocs 200-2019 contract states:
Owner will suffer damages which are difficult to determine and accurately specify if the Substantial Completion date, which may be amended by Change Order, is not attained. Constructor shall pay Owner $____ as liquidated damages and not as a penalty for each Day that Substantial Completion extends beyond the Substantial Completion date. These liquidated damages are in lieu of all liability for all extra costs, losses, expenses, claims, penalties, and any other damages of any nature incurred by Owner resulting from not attaining the Substantial Completion date.
In contrast, unliquidated damages are similar, but the amount of damages is not predetermined. In this case, the owner would need to show evidence of true loss to be reimbursed.
How liquidated damages work
The contract will specify the dollar amount of the damages for each day the project is delayed. Then, if a delay occurs (and it is determined to be the contractor’s fault), the contractor pays the owner the set amount for each day of the delay.
For example, if the contract specified liquidated damages of $500 per day and the project completion was delayed by three days, the prime contractor owes the owner $1,500 to cover lost income and additional costs.
Are liquidated damages a penalty?
Liquidated damages are not designed to be an unenforceable penalty. Their purpose is to compensate the owner for lost production, revenue, and added costs due to a schedule construction delay that is not their fault.
How liquidated damages are calculated
Liquidated damages are an attempt to reimburse the owner for losses that are difficult to substantiate or prove, so determining the amount of damages is partly a guessing game. However, there are some costs that are more defensible that others, including:
- Loss of rent
- Loss of income or profit
- Added costs, like storage or rent for second facility
- Financing costs, like loan interest
For example, let’s say a project owner is determining the liquidated damages for a tenant improvement project in a shopping mall. The owner determines that for each day the space in uncomplete, they are losing rental income from the tenant and are paying additional interest on their bank loan. If the monthly rental income for the space is $5,000 and the monthly interest expense is $700, they would calculate the daily rate for each of these expenses as follows:
- $5,000 x 12 = $60,000 / 365 = $164.38
- $700 x 12 = $8,400 / 365 = $23.01
- Total liquidated damages for one day = $187.39
Are liquidated damages enforceable?
There are only two situations in which liquidated damages are not enforceable:
- The contractor and its forces are not the cause of the schedule construction delay, or
- The court sees the amount of damages as exceedingly large or disproportionate to the owner’s actual losses.
If the general contractor, and anyone they are under contract with, is not the cause of the delay, they are not in breach of the contract and cannot be held liable for liquidated damages. However, if the delay was caused by a subcontractor or supplier on the contractor’s team, then the GC would be responsible. Assessing blame for delays can be tricky, so it’s important to document all changes to the work and potential delays, no matter who’s fault it is.
The contractor can challenge the amount of the liquidated damages specified in the contract through the legal system. If the court finds that the damages are excessive or are being levied in a way that seems punitive, then the court may find them not legally enforceable. The best way to avoid this situation is to carefully review the project contract and discuss the amount of liquidated damages before the contract is signed.
How to avoid liquidated damages
- Document all schedule changes and have the owner approve all delays that they cause. Owner-caused delays may include asking for extra work, delays in shipping owner-furnished materials or equipment, or submittal approval delays.
- Update the project schedule regularly so you know if completion will be delayed. If so, find ways to make up time by increasing manpower or working nights or weekends.
- If you feel that the damage rate is high, negotiate with the owner before the contract is signed to get a more reasonable rate.
Sometimes project delays are unavoidable. By documenting all delays and adjusting the schedule on a regular basis, you can forecast if the project will be completed on time. Increasing manpower and working added hours can help you get back on track and avoid liquidated damages.
Liquidated Damages Clause in Construction Contract
The liquidated damages clause in construction contracts is a fundamental provision that plays a crucial role in mitigating potential financial risks and uncertainties for all parties involved. This clause serves as a predetermined mechanism to address specific breaches of contract, particularly related to project timelines and completion. By establishing a predefined amount as compensation for damages incurred due to delays or non-compliance with agreed-upon conditions, the clause provides a clear framework for accountability. The inclusion of such a clause is intended to streamline dispute resolution processes, offering a fair and efficient means of addressing issues that may arise during the course of a construction project. It not only acts as a deterrent against potential delays but also provides a degree of predictability in assessing financial consequences. Crafting a well-defined liquidated damages clause in a construction contract is, therefore, essential for fostering transparency, minimizing uncertainties, and ensuring the smooth progression of construction projects.
How Do You Calculate Liquidated Damages in Construction?
The calculation of liquidated damages in construction typically involves a predetermined formula specified within the construction contract. Commonly, this formula includes a daily or weekly rate multiplied by the number of days or weeks of delay. For instance, if the contract stipulates a fixed amount for each day of delay, the total liquidated damages would be the daily rate multiplied by the number of days the project is delayed. It’s crucial for both parties to clearly outline and agree upon these calculations during the contract negotiation phase to ensure transparency and prevent disputes in the event of project delays or non-compliance with contractual obligations.
In conclusion, delving into the intricacies of liquidated damages in construction reveals a pivotal aspect within construction contracts. The inclusion of a liquidated damages clause in a construction contract underscores the contractual significance of predetermined penalties in the face of project delays or non-compliance scenarios. Understanding the nuanced calculation of liquidated damages in construction contracts becomes paramount for all parties involved, as it forms the basis for fair and just penalties. Examining an example of liquidated damages in construction provides practical insight into how these clauses operate, illustrating their role in maintaining project timelines and quality standards. In essence, liquidated damages carry a profound meaning in construction, serving not merely as punitive measures, but as instruments fostering accountability and adherence to contractual obligations. As stakeholders navigate the dynamic realm of construction, a comprehensive grasp of these concepts becomes indispensable for ensuring the smooth progression and successful completion of projects.