Construction contracts can be long, complex, and filled with all sorts of clauses and potentially harmful language that every contractor should look out for.
One of these clauses is a liquidated damages clause. This article will discuss what that means, why these clauses are used, and the real-world enforceability issues associated with liquidated damages clauses.
What are liquidated damages?
Liquidated damages are an amount of money, agreed upon by the parties at the time of the contract signing, that establishes the damages that can be recovered in the event a party breaches the contract. The amount is supposed to reflect the best estimate of actual damages when the parties sign the contract. These usually apply to a specific type of breach, and in construction, it is frequently the failure to complete work on time.
Liquidated damages clauses are usually written as some sort of formula, for example:
Total Contract Price – [(X amount of $ per day) x (number of days late)]
But let’s be real – we’re no mathematicians. Put into words: A certain dollar amount is multiplied by the number of days late, and that amount is taken out of the contract price.
Construction Contracts – Essential Info
- Construction Contracts: Guide & FAQs
- Construction Contract Review Checklist: What to Look for When Reviewing a Contract
- Contract clauses to beware of
- Construction contract template
Why include a liquidated damages clause?
Including a liquidated damages clause can provide many benefits, the most important of which is predictability. When setting a predetermined amount of damages, it allows both parties a chance to negotiate and settle on a number they both feel is fair and reasonable.
From the owner’s perspective, this acts like a cheap form of insurance against your contractors. In the event of a breach, the owner can immediately calculate the damages without going through the trouble of proving actual damages. Proving actual damages can be a complicated, lengthy, and costly process.
From a contractor perspective, this allows them to analyze the level of risk involved, and schedule appropriately. It also allows them the opportunity to limit the damage claims of the owner.
Are liquidated damages clauses enforceable?
Most states have statutes governing the use of these clauses in contracts. Some are very general and simple, stating that they must be reasonable under the circumstances at time of contract. Others are much more specific, requiring certain language.
Despite the fact that they seem great in practice, these clauses can be very difficult to enforce in court. Although they vary from state to state, the main elements that courts look at to determine the enforceability are the following:
- Actual damages are difficult to quantify
- Amount must be liquidated (i.e. agreed upon in advance)
- The amount must be reasonable
- Amount must be used as compensation, not as a penalty
- Must be the exclusive remedy for the type of breach specified
The bottom line
Liquidated damages are a good way to add more security and predictability to your construction contracts. However, as discussed, enforceability of these clauses is not guaranteed. As always, it’s important to familiarize yourself with your state’s specific statutes dealing with these clauses. Liquidated damages clauses can be helpful, but enforcement is at the mercy of a judge. And that can be highly unpredictable.