Liquidated Damages For Delay in Construction Contracts

Ronald L. Wallenfang, Coordinator
Construction Law Group

It is common in construction contracts, especially in public construction, for contractors to be assessed damages for late completion based on a fixed amount per day. These deductions are usually called "liquidated damages". Because the calculation and proof of actual losses resulting from contractor caused delays may be difficult, liquidated damage clauses are often popular with owners. Owners of public facilities like roads and schools may be specially interested in using a liquidated damage clause, because much of the "loss" they suffer may be inconvenience that is not easy to reckon in dollars and cents.

Generally speaking, a liquidated damage clause will be enforced by the courts if the estimated damages reasonably foreseeable at the inception of the contract bear some fair relation to the liquidated amount stated in the contract. If the stipulated amount is too high, the clause will be declared invalid as a "penalty."

Sometimes liquidated damage clauses are referred to in the industry as "penalty" clauses. If they really are a penalty rather than a reasonable estimate of damages, then they will not be enforced. While the reality is more important than the rhetoric, the term "penalty clause" should in all events be avoided.

Of course, for an owner to enforce a liquidated damages clause, it is necessary, not only that the daily rate be reasonable, but also that the delay not be excusable or even compensable to the contractor. Essentially, that involves a determination of whose fault caused the delay and may involve an allocation of fault among more than one responsible party.

One common misconception about "liquidated damage" clauses is that they can only be enforced where there is an offsetting bonus to the contractor in the event of early completion. There is no such requirement. Another common misconception is that, in the event the liquidated amount is unenforceable, the contractor has no exposure. That is also untrue. In that event, the owner still may attempt to calculate and prove its actual losses due to the contractor’s delay. Especially in the case of private facilities like rental apartments that lose income, these actual losses may be very substantial. Therefore, in some circumstances, a contractor would actually be better served by a modest liquidated damages rate than by exposure to a claim for actual damages. Nevertheless, in general, contractors are markedly less enthusiastic about liquidated damage clauses than owners.

In order to prove the reasonableness of a liquidated damage clause, the owner must compare the rate stated in the contract with its reasonably anticipated loss, based on circumstances existing at the time the the contract was written. To facilitate this effort, it is prudent (though not required) for the owner to calculate an estimate of its likely damages beforehand, at the time the liquidated damage clause is determined, and to keep that calculation available, in case questions arise later.

In the absence of any better information, a rule of thumb this writer uses as a conservative estimate of actual damages is $20 to $25 per calendar day for each $100,000 of contract price.

That amount approximates the investment value of the contract amount (were it invested elsewhere) and should stand a good chance of enforcement, since the owner wouldn’t normally make the investment without anticipating that it is at least as worthwhile as alternative investments.