Managing the Risk of Project Delays through Liquidated Damages Provisions

February 25, 2019

In construction projects, delays can be costly.

Project owners concerned that the late completion of a project will prove expensive for them may seek to include a liquidated damages provision in the construction agreement, which typically provides a method for calculating damages recoverable by an owner in the event the contractor breaches the agreement by failing to complete the work in a timely manner. While consenting to such a provision can pose financial risks for contractors, it can also lower the contractor’s risk of exposure to liability, provided the schedule and the compensation amounts are fair to both parties.

 

Generally, liquidated damages are damages defined in the construction contract that are assessed against the contractor for unexcused delays in achieving substantial completion of the project by the contract completion date, or in completing phases of the work by certain interim dates. In signing a construction contract with a liquidated damages provision, the parties agree that if the construction extends beyond the contractually mandated completion date, the contractor will pay the owner a “liquidated” sum in lieu of the damages the owner would incur, usually for each day, week, month, or year of delay. Thus, liquidated damages are a substitute for the “actual” damages an owner would otherwise be able to recover in the event of unexcused project delay, and are intended to provide compensation for damages that might be difficult and costly to quantify and prove.

 

The dollar amount of liquidated damages should be based on reasonable estimates of the losses the owner could incur in the event of a delay, as liquidated damages amounts that impose unreasonable penalties on the contractor, rather than providing reasonable compensation to the owner for their losses, are usually not legally enforceable. While the use of a liquidated damages clause is likely to incentivize the contractor to deliver the project on time, the damages may be deemed to constitute a penalty for the contractor if they exceed a reasonable estimate. Thus, amounts that appear to be speculative or punitive may not hold up in the event of litigation. It is therefore essential that contractors and owners carefully analyze and calculate anticipated delay damages when drafting the contract, and document their reasoning in written form.

 

From the owner’s standpoint, liquidated damages may be seen as compensation for a range of potential costs associated with delayed completion, such as lost rent or sales revenues, additional construction loan interest, lost tax incentives, additional construction administration and management costs, and extra insurance costs. From the contractor’s point of view, the contract completion date should allow for enough time to finish the project, with some room for contingencies; and the liquidated damage amount should not be so high that the assessment of liquidated damages would threaten the company’s financial stability. The liquidated damages clause should also include provisions that excuse delays for circumstances beyond the contractor’s control, such as strikes, shortages of materials, fires, floods, and other acts of God.

 

Including a liquidated damages provision in a construction contract based on a reasonable completion schedule and realistic amount can have advantages for both the owner and the contractor. In addition to providing the owner with an assurance of the amount of compensation they would be entitled to assess in the event of delay, a liquidated damages clause provides contractors with an exact figure of what their risk exposure would be if their work is delayed, and can help them organize the timing and sequencing of their work. Moreover, both parties might avoid the cost and complexity of resolving delay-related disputes in court or through arbitration. By giving the issue of liquidated damages the attention it deserves when drafting the contract, both owners and contractors can protect their financial interests.

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