Should Commercial Owners Require Liquidated Damages?

Commercial owners often capitulate when contractors hesitate to agree to liquidated damages for construction project delays. More often than not, owners should demand that contractors accept liquidated damages, in lieu of an owner reserving its rights to seek delay damages through the claims and/or dispute resolution process. 

What Are Liquidated Damages?

Liquidated damages ("LDs") are most commonly defined as a contractually agreed-upon amount that is a reasonable estimation of an owner's actual damages if the contractor fails to achieve a particular milestone or substantial completion of a construction project by an agreed-upon date.

• LDs are:
  • usually stated as a per day dollar amount;
  • onot a penalty for delays;
  • most appropriate when an owner's loss due to a potential delay is difficult or impossible to quantify in advance;
  • a way for both parties to a construction contract to define their monetary risk in the event of a delay; and
  • usually the only damages to which an owner is entitled in the event of a delay (when LDs are contained in a construction contract). 

Benefits of LDs

• Helps ensure a construction project is completed on time.
• Avoids the need for (and expense of) an owner calculating actual damages and proving those damages through the claims and/or dispute resolution process.
• A well-drafted LDs provision usually 1) permits an owner to demand that contractor pay LDs promptly after they are incurred or 2) allows an owner to withhold amounts owed due to LDs from progress payments or final payment.

Downsides of LDs

• Contractors will likely seek to "pad" the construction schedule, which may mean a later construction project completion date. This can be mitigated by an owner providing contractors with a preliminary construction schedule.
• Contractors and subcontractors may refrain from bidding on a construction project with LDs or propose a larger than usual contingency amount.

Making LDs More Palatable

If general contractors push back on LDs for a construction project, an owner can propose the following to make LDs more acceptable to contractors.

• Make LDs recoverable after a short "free period" (e.g., LDs begin on the 8^th day after the agreed-upon substantial completion date).
• Agree to a graduated LDs amount (e.g., $300 for days 1-7, $500 for days 8-14, $700 for days 15+).
• Owner can elect to provide the contractor a per day "early completion incentive" if the contractor completes the project early.
• Explain to the contractor that LDs are a good way to convert an unknown or uncertain risk (an owner's potential uncapped delay damages) to a known risk (a flat, per day amount) and that it can pass some of this risk down to its subcontractors.
• Agree to cap the total amount of LDs that contractor may be required to pay. Note that agreeing to such a cap may cause an owner to be unable to recoup all of its potential damages in the event of a lengthy delay in the completion of a construction project.

Types of Liquidated Damages

When an owner seeks to estimate liquidated damages, it should consider the following "types" of damages that it may incur in the event of a delay.

• Temporary accommodations for owner's staff unable to move into a new building
• If applicable, temporary accommodations for residents or customers unable to move into a new building
• Loss of income
• Loss of revenue or profit
• Storage costs (e.g., FFE, delivered materials)
• Rental costs
• Fees and fines imposed by jurisdiction, lender, investor, etc.
• Finance or loan costs
• Additional project administration costs after the agreed-upon substantial completion date (e.g., owner's representative costs, architect or designer costs, potential general conditions costs for new contractor if current contractor is terminated)
• If applicable, damages and penalties from grant authority
• Cost implications to third-party contracts
• Loss of tax or investment incentives
• Additional insurance, utilities, and equipment costs
• Subcontract price escalations (e.g., new hourly rates in the event of a rollover into a new fiscal year)

Owners should consult counsel familiar with construction contracts to determine whether LDs are appropriate for their construction project.