Liquidated damages clauses in construction contracts offer contracting parties certainty about the cost of late or incomplete performance. Liquidated damages specify a sum of damages that represents damages that the non-breaching party is likely to incur should timely completion of a milestone not be met. When used properly, liquidated damages eliminate the uncertainty and expense of litigating the question of the actual costs of the breach. When used improperly, states reject them as unenforceable penalties. And when in doubt about the enforceability of a liquidated damages clause, courts favor unenforceability.
What makes a liquidated damages clause an unenforceable penalty? Generally, a party seeking to assess liquidated damages must prove that (1) the injury caused by the breach was difficult or impossible to estimate at the time of contracting, and (2) the sum agreed upon is a reasonable estimate of the probable loss that will result from the breach. Some states, like Georgia, require an additional showing that the parties must intend to provide damages rather than a penalty. A few states, such as Montana, have declared liquidated damages clauses void absent exceptional circumstances.
Liquidated damages are included in contracts when actual damages would be difficult to prove in the event of a breach. The alternative involves the non-breaching party proving to a tribunal what actual damages (i.e., direct labor and material costs, extended monitoring costs, design consultant fees, etc.) are directly traceable to the breach. Thus, to assess liquidated damages, a party must establish that damages for delay were difficult or impossible to estimate at the time of contracting. For example, in a 2009 case captioned Carrothers Construction Co., L.L.C. v. City of South Hutchinson, the contractor challenged the enforcement of a liquidated damages clause in a contract for the construction of a wastewater treatment facility in Kansas. The Supreme Court of Kansas approvingly noted that “a project with this level of complexity” posed significant difficulties in estimating actual damages in the event of delay. Additionally, the court approvingly noted that the city’s engineer ran calculations “as a part of the contract drafting process” to estimate damages in the event of breach. This fact reassured the court that the city was aware of the need to quantify liquidated damages before construction began due to the difficulty of estimating damages in the event of the contractor’s delay. The court found the clause to be enforceable.
The liquidated damages sum must be a reasonable estimate of the probable loss. In a recent case before the Court of Appeals of Georgia, City of Brookhaven v. Multiplex, LLC, the court concluded that the liquidated damages clause for delay was not a reasonable estimate of actual damages. The court pointed out that the city made no effort to calculate what damages it stood to incur from delay prior to execution of the contract to construct an elementary school and park. The city testified that the liquidated damages amount of $1,000 per day was a “standard” sum that it included in many of its public contracts. The city also contended that the amount was less than 0.0004% of the total project cost. However, the city did not reasonably attempt to calculate additional labor costs, additional use of facilities, consultant costs, equipment rental costs, and other unknown variables that it would be forced to expend. The commonality of the sum cut against the city’s position, and the low rate of liquidated damages without more did not sway the court.
Before implementing a liquidated damages clause, owners and contractors should be aware of how liquidated damages clauses limit a non-breaching party’s options after breach. Two notable examples include contributory delay and a constructive damages cap.
A non-breaching party’s entitlement to liquidated damages can be reduced by the non-breaching party’s contributory delay. An Eighth Circuit Court of Appeals case applying Arkansas law, S.O.G.-San Ore-Gardner v. Missouri Pacific Railroad Company, demonstrated that Arkansas disfavors recovery by the party assessing liquidated damages in such scenarios. S.O.G., the contractor, entered into a contract with the Railroad, the owner, for the alteration of the Benzal Bridge over the White River, which involved the replacement of the central pier and swing span. The Railroad had also entered into a separate contract with the U.S. Coast Guard and the U.S. Army Corps of Engineers for reimbursement of reasonable and legitimate costs. S.O.G. had a duty under its contract with the Railroad to communicate with the Coast Guard and the Corps of Engineers to obtain necessary permits to proceed with construction. Due to several unexpected challenges, including delay in securing the permits, S.O.G. completed the piers one year behind schedule. During litigation, S.O.G. offered evidence that the Railroad contributed to the delay by failing to timely provide vital information about the project to the U.S. Army Corps of Engineers, thereby contributing to the delay. Because of the Railroad’s contributory delay, the court affirmed the District Court’s holding that the Railroad could not recover liquidated damages. The Eighth Circuit also affirmed the District Court’s denial of apportionment of liquidated damages for contributory delay for two reasons. First, Arkansas law prohibits apportionment in cases where both parties have contributed to the delay. Second, the court concluded that the delineation of fault would have been too difficult to determine.
Other states may apportion liquidated damages on such facts as seen in S.O.G.-San Ore-Gardner v. Missouri Pacific Railroad Company. For instance, in Hutton Contracting Co., Inc. v. City of Coffeyville, the Tenth Circuit Court of Appeals applying Kansas law apportioned liquidated damages between the contractor and the city. There, the contractor untimely constructed a power line and a fiberoptic line. The jury in the District Court below found that the city caused 23 days of delay by not responding to requests for extensions due to weather delays, not responding reasonably to the submission of close-out documentation, and not disclosing critical close-out documentation until threatened with legal action. The District Court awarded the city $85,500 in liquidated damages, which was drawn out of the $110,000 retainage sum agreed to by the parties at the time of contracting. The District Court ordered the city to pay the contractor the remaining $24,500. Thus, the contractor did not suffer any losses. The Tenth Circuit affirmed the District Court’s decision to apportion damages.
Liquidated damages clauses limit a party’s ability to recover actual damages. Courts are mindful not to allow a windfall to a party assessing liquidated damages. Therefore, courts will not permit parties to recover both liquidated and actual damages for the same breach. In Canstar v. Jones Construction Co., the Supreme Court of New York, Appellate Division, held that the liquidated damages clause in the contract limited delay recovery to $1,000 per day. The party seeking to enforce the liquidated damages clause was capable of proving higher actual damages, but the liquidated damages clause acted as a bar. Likewise, in Sweatt v. International Development Corporation, the Court of Appeals of Georgia found that the liquidated damages clause in the residential purchase and construction agreement foreclosed recovery of actual damages.
As with the contract negotiation process, careful consideration and preparation can provide an owner or contractor certainty and one less fight should a dispute arise down the line. Liquidated damages clauses can differ from state to state. To ensure successful implementation of liquidated damages clauses in your contracts, contact a competent construction attorney.
Smith Currie Oles provides comprehensive legal services to all parts of the construction industry across the nation. Smith Currie lawyers have decades of demonstrated success representing construction and federal government contracting clients “From the Ground Up,” including procurement matters, contract formation and negotiation, project administration, claims prosecution and, when necessary, in litigation and other forms of dispute resolution.
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