Liquidated damages are a fact of life in modern construction contracting. However, even if your contract contains a liquidated damages provision and the owner has assessed liquidated damages, that does not mean the assessment is valid or enforceable. There are a number of ways you might be able to prevent an owner from keeping contract proceeds that are rightfully yours. This article will provide the reader with an idea or two that will help keep hard-earned contract proceeds in the contractor’s pocket.
In a breach of contract situation, liquidated damages are designed to provide a means to compensate the non-breaching party when the actual damages are not readily ascertainable. In other words, when the non-breaching party’s actual damages will be difficult to determine in the event of a breach, then the parties are allowed to stipulate in their contract that a set sum of money will be paid in lieu of having to prove the actual damages. In construction contracts, the liquidated damages clause is usually tied to timely completion of the work by the contractor and usually allows the project owner to collect liquidated damages upon late completion. For example, for each day that the work is not complete past an agreed upon date, the contractor will have to pay the owner X amount per day. Liquidated damages can be agreed to in any type of contract, and not just construction contracts. In a real estate sales contract, the parties might stipulate in their contract that if the buyer reneges and fails to close, then the seller gets to keep the earnest money deposited by the buyer.
Is it Really a Penalty?A liquidated damages amount is intended to compensate the owner for the other party’s breach of the contract. If the provision seeks to do anything other than provide reasonable compensation, then the clause is really a penalty and, as such, will not be enforced. Merely because the parties title the provision as a “liquidated damages” provision is not determinative of whether it is really a penalty. Whether a provision is a valid liquidated damages clause or an unenforceable penalty depends on the facts of each case.
For example, if a provision that is labeled “liquidated damages” is not intended to compensate the owner, but is really intended to coerce the contractor into completing the work on time, rather than compensating the owner for delay damages, then the clause is a penalty. Similarly, if at the time the parties entered into the contract, the owner’s actual damages are “reasonably ascertainable,” then there is no reason to stipulate to the liquidated damages amount and it will not be enforced.
Another argument that has succeeded in voiding an otherwise valid liquidated damages clause is where the liquidated damages amount “shocks the conscience” of the court. In other words, if the stipulated sum is simply too great in comparison to the contract value itself, then the liquidated damages will not be enforced. This analysis compares the stipulated sum with the contract value. For example, in Hook v. Bomar, 320 F.2d 536 (5th Cir. 1968), the loss of a $30,000 deposit on a $95,000 contract was found unconscionable, and the liquidated damages provision was not enforced.
Liquidated damages tied to completion of the work generally cannot be assessed after the project has reached substantial completion. Liquidated damages are intended to compensate the owner for late completion, and by definition at substantial completion the owner has functional use of the project. Thus, at substantial completion, the owner is no longer incurring damages.
By way of illustration, on a construction project an owner may want $1,000 per day in liquidated damages to compensate the owner for lost rent and extended project administration for each day the work is not complete. However, once the project is substantially completed, the owner can rent the property, so that portion of the owner’s damages included within the stipulated $1,000 per day is no longer being incurred. If the owner seeks the entire liquidated damages amount for days after substantial completion until final completion, a strong argument can be made that no post-substantial completion liquidated damages are allowed even if the owner is incurring continued administration costs. The better liquidated damages clause would state that upon substantial completion, the liquidated damages will be reduced to $500 per day or some other reasonable figure to compensate the owner for the extended project administration required to obtain final completion of the project.
Owners routinely withhold contract proceeds under the argument that the contractor is liable for liquidated damages. However, even if it appears that the liquidated damages are proper, the prudent contractor will not accept the assessment at face value because there are many ways to defeat a liquidated damages clause. Hopefully, this article will provide the reader with a way to recover the withheld funds.
Author’s note: The information contained in this article is for general educational information only. This information does not constitute legal advice, is not intended to constitute legal advice, nor should it be relied upon as legal advice for your specific factual pattern or situation.