Your Contract has a Liquidated Damages Clause: Now What?
Imagine this common scenario: you have completed your work as a contractor on a construction project, your contract with the owner contains a liquidated damages (LD) clause, there are delays on the project, and you receive notice on behalf of the owner that you are going to be assessed liquidated damages. What should you do now? Aside from contacting your attorney, should you immediately write a check to the owner? The answer is no. Just because the owner put you on notice of its intention to assess LDs, does not mean that you are liable. Instead, there are multiple defenses that you, as a contractor, may have to the assessment of LDs.
By way of brief background, LD clauses are common in construction contracts, including the standard-form contracts of the American Institute of Architects. These clauses typically require a contractor to pay a fixed sum, for instance, $500 per day, for each day of delay in completion of the project. In most jurisdictions, including Pennsylvania and New Jersey, an LD clause is enforceable provided that the LD amount represents a reasonable estimate of damages in the event of a delay, rather than a penalty. There are two typical defenses to the assessment of LDs: 1) the delays on the project were not the contractor’s fault, and 2) the LD amount is unreasonable.
Regarding the first defense, it is well-settled law that an owner may not retain LDs for the portion of a delay attributable to the owner’s actions. So, any periods of delay that are caused by the owner, should be deducted from the LDs assessed. Additionally, if there are other delays not within the contractor’s control, such as delays caused by 1) extreme weather (categorized as an “Act of God”); 2) certain unforeseen site conditions; or 3) another contractor, there may be a basis to have the LD amount reduced for those portions of the delay.
Preparing this defense begins at the time of the delay. You should keep detailed documentation pertaining to periods of delay and advise the owner in writing regarding periods of delay that are not your responsibility.
Regarding the second defense, the LD amount must be a reasonable forecast of the owner’s damages due to delay. While this seems straightforward, it has become increasingly common for an owner or its representative to choose a standard amount in all of its contracts, whether it be $500 or $1,000 per day, without actually performing any analysis estimating likely damages. This is improper and is a basis to have the assessment of LDs invalidated.
Similarly, an LD clause can be invalidated if a contractor can show that the LD amount is not tied to the amount of damages expected or actually incurred. For instance, if the owner identifies the purpose of the clause to “insure adherence to the schedule” or to “encourage the contractor to complete the project on time,” this is improper. Additionally, in some states, like New Jersey, where the LD amount assessed is “grossly disproportionate” to the actual damages sustained, a court may invalidate the assessment of liquidated damages.
Some owners may also attempt to assess both LDs and actual damages for the period of delay. In fact, some contracts may contain language allowing the owner to do so. But, an owner is not entitled to a double recovery. As a result, if the LD clause is enforceable, then the owner only can recover LD damages for the period of contractor-caused delay, not actual damages. If the LD clause is unenforceable, then the owner is required to prove its actual damages for the period of contractor-caused delay. Thus, even if the owner’s notice of intent threatens LDs and actual damages, the owner is not entitled to both.
In addition to the two most typical defenses to an assessment of LDs, there also may be defenses found in the contract itself. For instance, the owner may have been required to meet certain notice requirements. If those requirements were not met, then the assessment can be challenged on this basis.
Also, it is possible that the owner could be considered to have waived its ability to assess LDs through its conduct. Specifically, if the owner authorized a shutdown of a project for the winter with construction to resume in the spring, the owner likely waived its ability to assess LDs for the shutdown period. Under this scenario, it is advisable to confirm in writing at the time of the delay that LDs will not be assessed.
In short, there are a number of valid defenses to the assessment of LDs, but those defenses form at the time of the delay. In order to protect your business, it is crucial that you know how to proceed during periods of delay, how to document delay caused by others, and what to do when you receive a notice of intent to assess LDs. You should consult an attorney if you have questions regarding an LD clause in a particular contract or how you should deal with delays on a project that has the threat of LDs.
