The Solid Truth About Liquidated Damages

Michael Catania is a Managing Partner with Catania, Mahon & Ryder and head of the Construction Practice Group. mcatania@cmrlaw.com Many contractors view liquidated damages (LDs) as unfair penalties forced upon them by owners as a means to guarantee aggressive project schedules. Some contractors even walk away from an otherwise highly profitable project when an owner refuses to remove or reduce LDs.

However, some of the tri-state’s largest and most successful construction firms are far less concerned, and even welcome, LDs. Why? They have a clear understanding of what LDs are, the liability potential they replace, and how to mitigate against their assessment through the inclusion of other contractual provisions.They view LDs more as a liability limitation than a potential profit loss.

Understanding LDs

First, the contractor needs to understand what LDs are and, more importantly, what type of potential liability/damages they seek to replace. Although subject to various limitations, interpretations, etc., LDs should be reasonable

approximations of damages an owner might suffer should the contractor fail to timely complete the project. The “estimate” part is key, as LDs are enforceable only where actual damages are too difficult to ascertain at the time of contract execution. [1] that the stipulated sum may be less than the actual damages allegedly sustained by the injured party.[4] So, assuming the contract contains proper LD language (see below), an owner’s delay damages are capped regardless of its actual damages.

For example, XYZ Corp. is developing a $50 million mixed-use project with a 2-year completion date. It has financed the project through a construction loan, hired a design team and an owner’s representative, purchased the necessary insurance, and even pays for temporary heat and light. What extra costs will XYZ Corp. incur if the project comes in three months late? More importantly, how could it accurately determine such costs two years before anticipated completion? For example, any estimate of lost profits/rental income would necessarily be based on assumptions, i.e., that tenants have been found, leases signed, and municipal approvals and certificates of occupancy obtained. Even increased financing costs could change dramatically over two years depending on the type of loan and ability to refinance.

Nevertheless, XYZ Corp. should be able to reasonably estimate its additional per-month costs for maintaining the project staff and site, interest payments on construction financing, and maybe even what anticipated market rents for the finished spaces could be, and determine an approximate per-diem amount of these added expenses/ losses. That per-diem amount could then be written into the contract’s LD clause.

However, if XYZ Corp. goes too far in the amount of LDs demanded in the contract, such that a court may interpret the LD provision to be a penalty rather than reasonably approximate compensation for loss, the LD provision will not be enforced.[2]

Second, contractors should consider an LD clause as a potential cap on liability, specifically as to delay damages. Why? Because an owner cannot recover both actual and liquidated damages, as liquidated damages are in lieu of, not in addition to, other compensatory damages. [3]

A valid liquidated damages clause controls the rights of the parties in the event of a breach, notwithstanding

Potential Savings

Continuing on with the above example, what if XYZ Corp. sets LDs at $1,000 for every day the contractor is over the completion date? At the time of bid, the contractor knows that even in the worst-case scenario (unexpectedly long lead times, subcontractor issues, weather-related delays), completion could be delayed by no more than two months. This “worst-case” scenario would cost the contractor no more than $60,000. Depending on the size of the project and the anticipated profit margin, the contractor may accept this number as a reasonable amount or increase its bid accordingly.

Now assume the contractor is awarded the job and, as the completion date nears, it is running three weeks behind. Typically, it would have to accelerate (via overtime, double shifts, etc.) to avoid what could be significant delay damages. However, with LDs fixed at $1,000 per day, the contractor can now compare the costs of acceleration with the $21,000 deduct for a 3-week delay and choose the less costly option.

Importance of Contractual LD language

Notwithstanding everything above, and in limited circumstances, owners have been able to recover LDs and their actual delay damages. How? Typically, it is a result of overly narrow and restrictive contractual language regarding LDs. A 2019 case involving the Dormitory Authority of the State of New York (DASNY) is a good example of this. Its contract had an LD clause that sought to compensate DASNY for the “loss of beneficial use of the Work.” However, a separate contract provision purported to allow DASNY to recover any “actual damages” sustained by the contractor’s delay aside from the “loss of use” covered in the LD clause. The court, holding that it was “readily apparent” from these two provisions that the parties had agreed to both LDs and certain actual delay damages, denied the contractor’s

motion to dismiss DASNY’s claim for “extended design and construction management fees totaling $613,000.”[5]

How can the above outcome be avoided? First, make sure that the LD clause does not restrict the type of delay damages it is meant to replace. Second, expand the LD clause to include all costs, claims and damages that in any way relate to delay in completion. ConsensusDocs’ standard Owner-Constructor LD clause is an excellent example of this type of language, including “all liability for all extra costs, losses, expenses, claims, penalties, and any other damages of any nature incurred by Owner resulting from not attaining the Substantial Completion date.”[6]

Final Considerations

LDs are negotiable. Owners are often willing to compromise on the amount and language of LDs. They may also consider a cap on total liability, typically tied into the contractor’s profit. Further, LDs do not have to commence immediately after a missed substantial completion date. Many contracts provide a “grace period” during which LDs will not be assessed. Finally, an owner who insists on large LDs is likely to experience financial gain should the project come in early and might be very amenable to an early completion bonus.

[1] Melwood Const. Corp. v. State, 126 Misc. 2d 156, 157, 481 N.Y.S.2d 289, 290 (Ct. Cl. 1984), aff’d, 119 A.D.2d 734, 501 N.Y.S.2d 604 (1986).

[2] City of Rye v. Pub. Serv. Mut. Ins. Co., 34 N.Y.2d 470, 315 N.E.2d 458 (1974) (“If [the LD provision] is grossly disproportionate to the anticipated probable harm or if there were no anticipatable harm, the provision will not be enforced.”)

[3] Levitt Corp. v. Levitt, (E.D.N.Y. 1978) aff’d 593 F.2d 463 (2d Cir. 1979).

[4] X.L.O. Concrete Corp. v. John T. Brady & Co., 104 A.D.2d 181 (1984), aff’d, 66 N.Y.2d 970 (1985) (Holding that “even though its actual delay damages may, in fact, be greater than $2,000 per day, N.Y.U. is, as a matter of law, limited to the sum for which it bargained.”)

[5] Framan Mech., Inc. v. Dormitory Auth. of State of New York, 63 Misc. 3d 1218(A), 114 N.Y.S.3d 814 (N.Y. Sup. Ct. 2019)

[6] ConsensusDocs® 200 Standard Agreement And General Conditions Between Owner And Constructor (Lump Sum) section 6.5 “Liquidated Damages”

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