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Commentary: Does Your Contract Call for Liquidated Damages or a Penalty?

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Many construction contracts, particularly on public projects, have liquidated damages provisions. Typically, those contracts fix daily amounts of damages for construction completion delays in their bid documents. They are then non-negotiable.

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However, most American courts do not look favorably upon liquidated damages provisions.  They question whether they are true estimates of costs the owner will incur because of delays in completion or are actually penalties for late completion or are merely incentives for contractors to work quickly. Courts do not like penalties. So they look at liquidated damages contract provisions with careful scrutiny when asked to do so.

So how do courts determine whether a contract provides for recoverable liquidated damages or is really just a penalty? They generally consider a number of factors in their analysis. Those include:

• Whether actual damages for delay would be difficult to determine,

• Whether the liquidated damages provision, including the dollar amount, was freely negotiated between the parties,

• Whether at the time of contracting, the dollar amount of liquidated damages was fixed as a reasonable estimate by the parties of the damages that the owner would suffer in the event of a delay.

If liquidated damages are contested, courts (or arbitrators) are likely to use their 20/20 vision to determine whether the owner did suffer actual damages as a result of construction delay. If so, they would compare the actual damages to the liquidated damages amount to determine reasonableness.

Public projects are rarely revenue producing, and new public projects do not typically result in savings of expenses that public entities would otherwise incur such as rentals of spaces to be replaced by new construction. It is not unusual that public entities do not suffer any dollar damages because of delays in the completion of their projects.

For example, construction of a new college classroom building may relieve overcrowding or obsolescence of existing classroom facilities but delay in completion of a new building would not likely cause the college to suffer any damages.

On the other hand, private-project construction completion delays are likely to cause owner damages such as loss of rental income, rental payments for facilities (or homes) to be replaced by the new construction, interest on construction loans, etc.

Case in point: The State of Colorado general conditions for its construction projects provide for a two-phase liquidated damages arrangement. The first phase is for liquidated damages for delays up to the date of substantial completion (when the project may be used for its intended purpose) and the second phase is for damages for completion delays beyond substantial completion dates to the date of final completion.

It appears that the inclusion of the Colorado state liquidated damages provisions are optional with the awarding authority. When they are included, and when dollar amounts are fixed in the bid invitation, the “freely negotiated” and “reasonable estimate” requirements of the courts are absent. Contractor-bidders can either “take it or leave it.”  Under those circumstances, it is highly likely that Colorado courts would be inclined to carefully compare the liquidated damages dollar amount fixed by the state with actual costs incurred by the awarding authority to determine whether the liquidated damages provision is reasonable or is an unenforceable penalty.

For example, the state’s second liquidated damages phase (the delay between substantial completion and final completion) identifies damages as those “. . . arising from administrative, technical, supervisory and professional expenses related to and arising from the extended closeout period.”  If, for example, a fixed dollar amount for those liquidated damages is in the neighborhood of $1,500 per day, that amount is likely to be unreasonable (and unenforceable) if the awarding authority only has its architect or owner’s representative involved at that “punch-list” stage.  It is unlikely that such person would be paid a whopping $45,000 a month.

Lesson:  When faced with an owner’s threat of assessing liquidated damages, particularly on public projects, contractors should carefully analyze the circumstances under which the liquidated damages provision was included in their contracts and whether the liquidated damages amounts fixed by their contracts were reasonably close to what damages the owner did, in fact, suffer as a consequence of any construction delay. In that exercise, contractors should also study the circumstances to determine the causes of the delay(s), who was at fault and other circumstances that might excuse or mitigate their delays.

Albert B. Wolf is a principal in the Denver law firm of Wolf Slatkin & Madison P.C.  This column was written with the intent of providing general legal information intended to be reasonably accurate although not comprehensive.  Readers are therefore urged to consult their attorneys for any specific legal advice they may desire concerning the subject matter of this column.

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