If you have ever read a construction contract carefully, you will come across liquidated damages clauses. A liquidated damages clause requires a contractor to compensate their client for the late completion of work. Payments stated in the clause might be up to $1,000 every day the contractor takes past the project deadline. However, are these payments enforceable by law?
A liquidated damages clause on a construction contract comes with standard disclaimers. On the clause, it states that actual damages caused to the client are impossible to determine in case the contractor does not complete the project on time as per the contract. In such a case, the contractor and the client enter into an agreement – they settle on a number and agree that the amount the contractor will pay is not a penalty. Failure to agree to a number and state that the payments are not a penalty might see the contractor defend themselves as being penalized for late completion. In most cases, though, attempts to claim liquidated damages by the owner may not always work as the law may not enforce the clauses unless the clause meets certain conditions as explained below. This article discusses instances when liquidated damages are enforceable by the court. For starters, what are liquidated damages?
What is Liquidated Damages?
Put simply, liquidated damages are estimates of losses incurred by the owner of a construction project where it is difficult to calculate and ascertain actual losses. Usually, in your look at the liquidated damages definition online, you will see that they are meant to offer a fair settlement and not punish the contractor.
In construction, liquidated damages apply when a contractor fails to complete a project on time as stipulated in the contract. The contractor, in this case, is said to be in breach of the contract. The market value of a building might be estimated before construction, but the accurate value of the building is set after completion – this way, the owner and the contractor might not tell the actual damages that an owner incurs every day a construction project delays. As such, the contractor and the owner comes up with a fair figure that represents losses the owner might make due to the delayed project. As an owner, you need to understand liquidated damages beyond the liquidated damages definition. You can read more on liquidated damages and when they are enforced from this piece by Procore.
When Can a Liquidated Damages Clause Be Enforced?
Courts enforce the liquidated damages clause under some circumstances. In most cases, the court makes a value judgment when deciding the case. This will involve the court identifying the legitimate interest for which the clause was included in the contract. The court will then look at the remedy. In cases where the liquidated damages clause comes as a secondary obligation and is detrimental to the contractor and appears that the owner's interest is to enforce the primary obligation, the clause will be unenforceable as a penalty. In simple liquidated damages clauses, the primary and secondary obligations are straightforward. In complex contracts and situations, the court will ask the non-breaching party whether the remedy is "unconscionable or exorbitant."
The first thing you need to know, either as a contractor or owner, is “what are liquidated damages?” – after that, you need to understand that for liquidated damages to be enforced, they need to meet the following three conditions:
Damages Must Be Difficult To Estimate
In instances where the damages can be estimated, the contractor would compensate the owner for all damages to the last coin. For the court to enforce liquidated damages, the damages incurred must be a result of a breach of contract and should be challenging to estimate once the contract is entered into. In some cases, it is easy to estimate the damages. For instance, if the breach of contract leads to loss of sales, the owner will only claim for lost profits. In the case of construction, a construction project that delays for a week might not lose value or any amount that the contractor or owner can accurately estimate. If the losses incurred are uncertain or cannot be quantified at the time the contract is entered into, the court will enforce liquidated damages.
The Amount Must Be Reasonable
A court will enforce liquidated damages in instances where the amount estimated is proportionate to the harm the breach is thought to have caused. However, in instances where the amount is grossly exorbitant, the court will view that as penalty or punishment and will not enforce the clause. To assess whether the amount is exorbitant or reasonable, the court will determine what was reasonable when the contract was signed and not when the breach occurred. In some cases, however, the court might decide to assess whether the amount is reasonable based on the harm the breach causes and not based on what was reasonable when the contract was signed.
Liquidated Damages Cannot Be Used to Punish Contractors
Once you understand what is liquidated damages, you will see that an owner cannot use them to punish a contractor. The liquidated damages clause is only meant to compensate the owner for losses they might incur and not to punish.
When estimating the daily liquidated damages, the owner should not base the amount on what he believes will force the contractor to finish a project on time. If they do that, the liquidated damages will constitute a penalty that is not enforceable. Instead, the owner must base their calculations on the exact amount they anticipate losing if the project extends past the contractual deadline – the calculations need to be reasonable.
In instances where the contractor and the owner understand what are liquidated damages and agree on a figure that will be reasonable, there is no need to go to court. However, in instances where the contractor feels they are punished or penalized with exorbitant damages, the court has to be involved. Every contractor and owner needs to know what is liquidated damages beyond the liquidated damages definition.