Liquidated Damages - A Primer

Disclaimer: This article is not legal advice and is purely for informational purpose and based on the Author's experience and review of other literature in this domain.

Introduction

Time is Money, and a delayed project impacts the Owner as well as the Contractor. A way of managing the risk of late completion is by using the provision of Liquidated Damages (LDs), which are defined in the Contract Agreement. Simply stated, Liquidated Damages are the price the Contractor must pay per day for finishing the project beyond the contract completion date. Since actual damages are typically hard to calculate before contract execution, Liquidated damage provision provides a straight forward method of calculating damages recoverable by an owner in the event of late completion. Liquidated Damages clause also provides a good schedule risk mitigation mechanism.

Contract Completion

To understand how Liquidated Damages are calculated, we start with the basics. The original contract completion date is that date set in the contract at which time the project is required to be complete. There may be different definitions of completion, like Substantial Completion and Final Completion. Therefore, the contract needs to be clear what completion date is used to assess the liquidated damages. Many contracts may have multiple interim milestones, with each milestone have a liquidate damage provision as well. Typically, contracts simply establish the number of days of performance instead of a specific date of completion, to factor for the uncertainty of when a project may be authorized to proceed.

Liquidated Damages

Liquidated Damages typically imply that the parties have expressly stipulated in the contract the damage amount to be recovered in the event of a contractor-caused delay, regardless of the actual damages incurred by the owner for the delay. The following need to be noted:  

1. The onus of determining the amount to be used as liquidated damages is on the Owner. The costs due to loss of use and the extended costs for the Owner when the project gets delayed are important in determining the liquidated damages. The extended costs include the costs of construction management, design services, in-house project management costs and other costs to support the contractors.
2. Owners and their consultants, must carefully document how the estimate was made. If challenged, the onus is on the owner to demonstrate that the liquidated damages provision was based on a reasonable forecast of actual damages.

There are number of costs that must be considered in calculating the liquidated damages. Some of these are:

·      Extended Overhead Costs: These are costs the Owner must incur to administer and manage the project beyond the original completion date. This includes the staffing costs for the agencies involved, staffing costs for the design team, program management teams and the construction management team. Additional costs include the costs of legal teams and other support costs.

·      Extended Temporary Costs: This includes costs to maintain temporary systems and facilities to support the project. This category can also include elements like traffic control, fire watch and other temporary measures.

·      Escalation: The calculations are based on today’s dollar value. An acceptable rate of escalation should be applied to account for the project completion time line.

·      Loss of Use Costs: This includes revenue loss for the public agency if the facility is not completed in a timely manner. For example, in toll roads the tolling may not be collected unless the project is completed on time.

Limits on Liquidated Damages: Typically liquidated damages are an estimate of the cost to the owner, due to a delay in beneficially using the project for its intended purpose. Based on this definition, substantial completion ordinarily cuts off the owners rights to continued assessment of liquidated damages against the contractor.

Actual Damages Vs Liquidated Damages:

Liquidated damages are not a penalty. If the Courts can figure out how much an owner has been damaged and that actual damage is so much less than the liquidated damages charged to the contractor to appear unfair then the liquidated damage provision may not be enforced.

Types of Delays: The two major categories of construction delays are 1) Excusable Delays and 2) Inexcusable Delays.

Delays not attributable to the Contractor’s actions or inactions are termed excusable delays. Liquidated damages are only applicable for Inexcusable Delays, or those delays are caused by the Contractor and its forces.

Excusable delay is important to a contractor in that it entitles the contractor to seek and receive additional time in which to perform its work. Further, as the delay is excused and the contractor is held harmless for of the delay, these delays entitle the Contractor to a time extension, thereby revising the original contract completion, and potentially avoiding liquidated damages. It must be noted that when Owners impose liquidated damages at the end of a delayed project, the Contractor typically try to counter it with allegations of concurrent delay, as a mechanism to excuse the liquidated damages.   

An Equitable Solution

LDs for delays are an effective means to calculate delay damages. However, parties should note that LDs can be assessed only for delays that primarily caused by the Contractor. Therefore, in complex projects, the assessment of LDs is complicated due to various concurrent delays involving detailed delay analysis strategies. Nonetheless, LDs provide a good mechanism and incentive for the Contractor to manage their schedule.