Opportunity or Bust: Why You should be Afraid of Liquidated Damages
By Peter Micevski, Lawyer, Lovegrove Smith & Cotton
Contractors often bemoan the topic of liquidated damages (otherwise referred to as “LDs”), and with good reason.
It should go without saying that it is best to avoid having to pay LDs in the first place. As hard as a contractor may plan and prepare, there is no guarantee that it will not fall behind schedule or miss critical deadlines.
If you choose to ignore the liquidated damages clauses in your building contract when you sign it up, and you subsequently delay the project, there is the potential for you to be exposed to potentially catastrophic amounts of money to the head contractor or principal under your building contract.
Building contracts, especially commercial building contracts, commonly contain ‘liquidated damages’ or ‘delay damages’ clauses which provide that a contractor is required to pay a pre-determined sum of money, usually for delaying the completion of the works under the building contract.
The parties agree upon the sum of liquidated damages at the time of entering into a building contract and the sum is intended to be a ‘reasonable estimate’ of any potential damages if the contractor delays the project or delivers equipment or materials past agreed deadlines.
Whilst it is all and well and good to say that theoretically, the parties ‘agree’ to the sum of liquidated damages, in practice this all truly depends on the extent of your bargaining power. This can be easier if you are a prime contractor or larger supplier, but if you are a subcontractor, negotiations may be more difficult. You just want the job, at least at the outset.
At law, liquidated damages can only be a “genuine estimate” of the loss that will be sustained in the event of a delay. In the case of a commercial construction subcontract it would be reasonable to charge the subcontractor a rate that is commensurate with the rate that the contractor must pay to the principal under the head contact.
Often however, subcontracts have liquidated damages provisions that are more onerous than the head contract. If a liquidated damages provision is held to be penal, it has no legal effect. But to prove that a liquidated damages provision is penal would necessarily involve initiating legal proceedings, which are expensive in themselves and not to mention stressful. In any event, the subcontractor may not entirely escape liability and will be liable to pay such damages, as the head contractor is able to prove.
In a time when competition for larger commercial building contracts amongst contractors is rife, more often than not we are seeing contractors sign up to liquidated damages provisions that have not been properly assessed and considered. Indeed, sometimes the more onerous subcontract agreements call for both LDs under that agreement plus the right for the head contractor to seek indemnity for any LDs they must pay under the head contract. In these circumstances, the LDs have the potential to financially cripple the contractor in the event that the contractor does not reach completion by the deadline date.
The next time you consider entering into a building contract, you need to be cautious of the amount of liquidated damages. Knowing your ultimate exposure for delays can help you decide whether to sign or not, or to bargain a less onerous deal.
It is advisable that you receive legal advice from experienced construction lawyers before you enter into a building contract. Your lawyer may be able to help you negotiate the best deal possible regarding liquidated damages.
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© Lovegrove Smith & Cotton 2014