Despite the introduction of best practice construction procedures and computerized critical path programming, many construction projects continue to exceed their intended contract duration. For a client, a delay means that the asset being built will be unable to be used when it was anticipated. This could result in the client incurring additional costs or experiencing a delay in obtaining income from the project. Delays in project completion may result in the contractor being liable to the client for delay damages.
Due to these uncertainties, most construction contracts pre-determine the damages that will be paid to the client in the event of a project delay. These are known as ‘liquidated damages’ (LDs). The inclusion of liquidated damages clauses in an agreement serves the important purpose of making it easier for an innocent party to be compensated when a defined trigger event happens. This is because the innocent party is not required to demonstrate that they experienced damage in order to become eligible for the stated sum, but only that the defined event or non-event occurred.
Timing Is Crucial in Construction Contracts
Construction contracts have extensive guidelines for determining when a contractor must complete the job promised to complete. A ‘reasonable time for completion’ will usually be assumed if no date is stated, based on the project’s requirements. Liquidated damages will not be charged if there is no set completion deadline. As a result, building contracts will have a set completion date that time extension clauses can extend. Extending the duration has advantages for both sides.
From a contractor’s standpoint, they cover delays that are neither the contractor’s fault nor duty. In most cases, if the completion time is legitimately extended, the contractor is not obligated to pay damages for the delay. From an employer’s perspective, it offers clarity on how the completion date will be determined and under what conditions it may be altered. It is meant to protect the right to claim liquidated damages for delays in appropriate circumstances.
Some contracts are detailed enough to provide for damages if planned activities are missed. In that instance, a contractor may be liable for several damages at the same time if things are delayed. Because there are so many mitigating variables that could cause a project to take longer than expected, the contract should include procedures for extending the timeline without incurring penalties.
Changes in the nature of the project made by the owner, for instance, should not be deemed the contractor’s fault. However, damages are a daily cost, and a time overrun can result in significant profit margin erosion, reducing a contractor’s economic reward on a project.
Getting Out of The Penalty Trap
In some cases, liquidated damages clauses may be unlawful and unenforceable since they punish the breaching party rather than merely compensating the innocent party. These terms are known as penalty clauses, and they should not be included in your contracts since they are unenforceable.
Differentiating Between a Penalty Clause and a Liquidated Damages Clause
A penalty clause penalizes a party if a specific trigger event occurs, such as a contract breach. The penalty is frequently a requirement to pay money to the innocent person over the loss that might be proven in damages claim. Another way to look at it is that a penalty provision also protects the innocent party’s legitimate commercial interests.
The courts have established specific standards to determine whether a clause is an unenforceable penalty clause or an enforceable liquidated damages clause.
Considerations that are relevant include:
- If the amount specified in the clause represents a “real pre-estimate of loss” rather than a “penalty.”
- In a claim for liquidated damages, a real pre-estimate of loss is valid, whereas a penalty provision is void or unenforceable, and the claimant must rely on damages claim.
- The degree of disparity between the defined sum and the loss that the claimant would suffer if the trigger event occurs
- The degree of disparity between the defined sum and the loss that the claimant would suffer if the trigger event occurs
Other variables to consider include establishing the conditions under which the contract was undertaken, the subject of the term in dispute, and the reason for incorporating the clause in the contract.
How to Draft An Enforceable Liquidated Damages Clause
Writing an effective and enforceable liquidated damages clause necessitates careful consideration of the loss that the provision is intended to safeguard against. When designing a liquidated losses clause, bear the following points in mind:
- Set out a specific sum of money or a formula that can be used to compute it, define the assumptions and justifications behind the amount or formula included in the contract
put out a precise sum of money or a formula that can be used to calculate the sum
- Define the assumptions and reasoning behind the amount or formula included in the contract
- Make sure the amount is equivalent to any loss you may incur and that it functions as compensation for this loss
- establish that the liquidated damages clause is a legitimate loss estimate
- State that each party has equal bargaining power and has an option to obtain independent legal counsel on the clause and the contract in general
Early Use and Partial Possession
Partial possession is when a client is permitted to take ownership of any part of the project with the approval of the contractor. If the client exercises this privilege, that segment of the task is essentially done. Most typical forms of construction contracts include terms that limit a contractor’s liability for liquidated damages proportionally if any part of the work is certified as complete before the contract is completed in full.
Early use occurs when a client is permitted to use or occupy a portion of the project before it is declared complete, with the approval of the contractor. Early use will leave the contractor with the risk and responsibility for the site and the operations. Thus, the contractor’s entire obligation for liquidated damages as indicated in the contract will continue. Nevertheless, if the client causes the contractor to be delayed or disrupted, the contractor may make a claim for loss and expenditure.
