Maximizing Recovery of Liquidated Damages

Jessica E. Sabbath | King & Spalding | January 9, 2019

During construction and commissioning of large-scale energy projects, every day of delay or failure to meet plant performance requirements can result in the owner incurring substantial damages. Indeed, power industry owners can incur damages such as additional financing and administrative costs, in addition to lost operating revenues, if the plant cannot operate as scheduled. Because such damages can be difficult to prove, EPC contracts for power projects commonly provide for liquidated damages, which are a fixed sum contracting parties agree will be payable as damages for a specified breach. Negotiating for such damages can benefit owners because the damages resulting from a breach can be difficult to calculate. A liquidated damages clause allows the parties to avoid burdensome and potentially costly litigation regarding the amount of actual damages and provides certainty in the event of a breach.

Before agreeing to liquidated damages, however, owners should consider whether they would be better off seeking to recover their direct damages in the event of a breach. If a contractor will not agree to an amount of liquidated damages the owner believes would cover its actual, direct damages, it may be more advantageous to seek actual damages, as long as they could be proven without too much difficulty. Depending upon the circumstances and the parties’ respective bargaining power, a liquidated damages clause may not always be the best option.

Owners should consider the following issues when contracting for liquidated damages:

Ensure Liquidated Damages Will Cover Anticipated Losses

As noted above, an owner should carefully estimate its potential losses in the event of a breach and ensure the liquidated damages will cover these losses. At a minimum, liquidated damages should cover the cost of carrying the contract for the delayed period, including additional overhead, financing costs, and personnel costs. Because the contractor and owner must agree on the amount of liquidated damages, owners should be prepared to make their case to contractors for the amount they are seeking at the negotiating table. Having an upfront meeting of the minds as to the full extent of prospective damages an owner expects to incur in the event of a delay will help ensure that the contractor fully understands the risks and provides a realistic schedule and work plan.

Take Precautions to Prevent a Finding that Liquidated Damages Are a Penalty

Liquidated damages are intended to compensate the injured party for its losses, not to penalize the breaching party. Thus, as a general rule, most courts require that liquidated damages be a reasonable pre-estimate of the anticipated losses at the time of contracting. Some courts, however, also consider the actual losses sustained to determine whether liquidated damages are reasonable. And a few jurisdictions (such as Connecticut and Rhode Island) will not enforce liquidated damages clauses if the injured party cannot prove it has sustained at least some actual harm or damage, regardless of whether the liquidated damages were reasonable when viewed prospectively.

Courts will not enforce provisions for liquidated damages that are deemed to be a penalty, and owners can take precautions at the time of contracting to prevent liquidated damages from being held unenforceable on this basis. For example, an owner should internally document how it estimated its probable losses at the time of contracting. Owners should also exercise caution not to say anything a contactor could interpret as a threat that it will be penalized for a delay.

Because liquidated damages cannot be penal, some courts (including those in New York, Florida, and Illinois) have held that a contract may not contain a clause allowing an injured party to choose whether to seek recovery of its actual damages or liquidated damages (sometimes called an optional liquidated damages clause). These courts have stricken optional clauses and limited the plaintiff’s recovery to actual damages on the grounds that such clauses would penalize the breaching party and defeat the purpose of stipulating to liquidated damages. Notably, however, some jurisdictions have upheld such optional clauses, including Colorado, Idaho, and Washington. As the Colorado Supreme Court explained, parties have the freedom to contract for alternative remedies, as long as they do not pursue both.[1] Owners may benefit from optional clauses in jurisdictions where they are enforceable.

Maximize the Scope of Covered Losses

While liquidated damages are generally used as a remedy for delay, liquidated damages clauses may also include performance elements. As long as the clause satisfies the operative requirements for enforceability, a contract may provide for liquidated damages if a contractor fails to timely complete work in accordance with specified performance criteria. For example, the parties may provide that if the contractor fails to deliver equipment in accordance with the contractual specifications and performance standards, it must pay liquidated damages for each day of delay. This would apply if the contractor delivers the equipment on time, but it fails to meet the required performance standards.

Most liquidated damages clauses provide for recovery of liquidated damages through the date of substantial completion because the project can be used for its intended purpose at that time. As one court explained, if the contractor fails to complete the outstanding work after substantial completion, the owner may hire someone else to finish and sue the contractor for its breach.[2] Nevertheless, courts have allowed recovery of liquidated damages until final completion where the contract clearly reflects the parties’ intent to provide for such recovery.[3] If an owner reasonably anticipates at the time of contracting that its losses will continue until final completion, or that it will not be able to operate and earn revenue until that time, it should attempt to provide for liquidated damages through that date.

Know When Damages Are Recoverable and What Law Applies

Owners should be mindful that they may not be able to recover liquidated damages for any period of concurrent delay, which occurs when the owner and contractor both cause a delay that impacts the same activity, each of which standing alone would have impacted the completion date. When both parties concurrently cause a delay, there is an old adage that a contractor may be entitled to “time but no money” because of the inherent difficulty in proving causation. While the law is unsettled, the modern trend is to apportion delay damages if there is sufficient evidence to determine the extent of the delay attributable to each party.[4] Even under the modern rule, however, an owner may not recover delay damages if there is insufficient evidence to make this showing because the delay can be attributed to both parties’ simultaneous actions, or if the owner acted in bad faith, substantially contributed to the delay, or made it impossible for the contractor to complete its work.[5] As a general rule, these principles apply regardless of whether there is a liquidated damages clause or the owner is seeking to recover its actual damages.

Finally, it is important to include a choice of law provision and be aware of the operative law. In most jurisdictions, the party seeking to recover liquidated damages must plead and prove the clause is valid, while the opposing party must show the absence of elements of the prima facie case and has the burden to prove the clause is an unenforceable penalty. But even though many courts apply the same general principles, some courts impose a higher standard to invalidate a liquidated damages clause.[6] There is even a presumption of validity in some jurisdictions.[7] And as noted above, some jurisdictions only require that liquidated damages be reasonable prospectively, while other courts also consider the actual losses sustained. While no one wants to contemplate disputes regarding delay damages at the time of contracting, owners can benefit if the contract is governed by a state’s law that tends to uphold liquidated damages and imposes a heavy burden on a party seeking to invalidate them.

Contractual Waiver of Consequential Damages

David Adelstein | Florida Construction Legal Updates | December 1, 2018

Contractual waivers of consequential damages are important, whether they are mutual or one-sided.  I believe in specificity in that the types of consequential damages that are waived should be detailed in the waiver of consequential damages provision. Standard form construction agreements provide a good template of the types of consequential damages that the parties are agreeing to waive. 

But, what if there is no specificity in the waiver of consequential damages provision? What if the provision just states that the parties mutually agree to waive consequential damages or that one party waives consequential-type damages against the other party?  Let me tell you what would happen.  The plaintiff will argue that the damages it seeks are general damages and are NOT waived by the waiver of consequential damages provision.  The defendant, on the other hand, will argue that the damages are consequential in nature and, therefore, contractually waived.   FOR THIS REASON, PARTIES NEED TO APPRECIATE WHAT DAMAGES ARE BEING WAIVED OR LIMITED, AND POTENTIALLY THOSE DAMAGES NOT BEING WAIVED OR LIMITED, WHEN AGREEING TO A WAIVER OF CONSEQUENTIAL DAMAGES PROVISION!

Interestingly, this issue appeared in the recent case, Keystone Airpark Authority v. Pipeline Contractors, Inc., 43 Fla. L. Weekly D2601d (Fla. 1stDCA 2018).   Here, a plaintiff sued a contractor and engineer for defects to an airplane hangar and taxiways.  The plaintiff claimed the engineer’s negligence through its failure to supervise the work as contractually required which resulted in defective construction.  The plaintiff claimed that the engineer was responsible for the costs to repair the airplane hangar and taxiways.   The engineer argued under a waiver of consequential damages provision that read:

“Passero [engineer] shall have no liability for indirect, special, incidental, punitive, or consequential damages of any kind.”  

The engineer argued that the damages the plaintiff was seeking due to its failure to supervise was excluded under the waiver of consequential damages provision in the contract.  The plaintiff argued that such damages are general damages and not barred.  The trial court, as affirmed by the appellate court, held that the damage was barred because the damage was consequential.  In doing so, the court examined the definitions of the types of damages:

General damages are ‘those damages which naturally and necessarily flow or result from the injuries alleged. . . . General damages  ‘may fairly and reasonably be considered as arising in the usual course of events from the breach of contract itself. Stated differently, [g]eneral damages are commonly defined as those damages which are the direct, natural, logical and necessary consequences of the injury.

In contrast, special damages are not likely to occur in the usual course of events, but may reasonably be supposed to have been in contemplation of the parties at the time they made the contract. They consist of items of loss which are peculiar to the party against whom the breach was committed and would not be expected to occur regularly to others in similar circumstances.  In other words, general damages are awarded only if injury were foreseeable to a reasonable man and . . . special damages are awarded only if actual notice were given to the carrier of the possibility of injury. Damage is foreseeable by the carrier if it is the proximate and usual consequence of the carrier’s action.

[C]onsequential damages do not arise within the scope of the immediate buyer-seller transaction, but rather stem from losses incurred by the non-breaching party in its dealings, often with third parties, which were a proximate result of the breach, and which were reasonably foreseeable by the breaching party at the time of contracting. The consequential nature of loss . . . is not based on the damages being unforeseeable by the parties. What makes a loss consequential is that it stems from relationships with third parties, while still reasonably foreseeable at the time of contracting. 

Keystone Airpark Authority, supra (internal citations and quotations omitted).

Based on these definitions, the court agreed that the repairs to the hangars and taxiways were not special damages as “[i]t cannot be said that repairs stemming from improperly supervised construction work are unlikely to occur in the usual course of business.”  Keystone Airpark Authority, supra.   Such damages did not involve special circumstances for which the plaintiff would be required to give the engineer actual notice. 

BUT… these damages were CONSEQUENTIAL:

[T]he cost of repair here did not constitute general damages, either, because the damages were not the direct or necessary consequence of Passero’s [engineer] alleged failure to properly supervise the construction work.  The contractor could have completed the job correctly without Passero’s supervision.  Thus, the need for repair did not arise within the scope of the immediate transaction between Passero and the Airpark.  Instead, the need for repair stemmed from loss incurred by the Airpark in its dealing with a third party – the contractor.  While these damages ‘were reasonably foreseeable,’ they are consequential and not general or direct damages.

The appellate, however, certified the following question of great public importance:

WHERE A CONTRACT EXPRESSLY REQUIRES A PARTY TO SUPERVISE CONSTRUCTION WORK AND TO DETERMINE THE SUITABILITY OF MATERIALS USED IN THE CONSTRUCTION, BUT THE PARTY FAILS TO PROPERLY SUPERVISE AND INFERIOR MATERIALS ARE USED, ARE THE COSTS TO REPAIR DAMAGE CAUSED BY THE USE OF THE IMPROPER MATERIALS GENERAL, SPECIAL, OR CONSEQUENTIAL DAMAGES?

Thus, there could be a ruling in future from the Florida Supreme Court relating to construction industry, specifically relating to the damages associated with a supervising architect or engineer.

Massachusetts SJC Clarifies “Strict Compliance” Standard in Construction Contracts

Jacob Goodelman | Construction Law Blog | November 27, 2018

In Massachusetts, it is well established that a contractor cannot recover damages from a construction contract without first showing that the contractor completely and strictly performed on all of the contract’s terms. Recently, the Massachusetts Supreme Judicial Court narrowed the rule by concluding that complete and strict performance is only required for contract terms relating to the design and construction itself. The high Court explained that non-design / non-construction contract terms are governing by “ordinary contract principles, including the traditional Massachusetts materiality rule.”1

In the case – G4S Tech. LLC v. Mass. Tech. Park Corp. – G4S Tech. LLC (“G4S”) brought suit against Mass. Tech. Park Corp. (“MTPC”) alleging MTPC owed G4S $4 million of a $45 million contract after G4S completed the build of a fiber optic network in western and north central Massachusetts.2 MTPC maintained that they withheld the $4 million because of substantial delays in the project.3 MTPC in turn brought counterclaims against MTPC alleging fraud and violations of the Massachusetts Consumer Rights Act. Specifically, MTPC maintains that G4S fraudulently and intentionally delayed payments to subcontractors in violation of the construction contract.4 The SJC held that the contract provisions dealing with the “timing of payments to subcontractors and the documentation concerning those payments” is not a contractual term relating to the design or the construction of the fiber optic cable itself.5 Thus, the SJC analyzed the alleged violations under the Massachusetts materiality standard as opposed to the strict and complete performance standard.6 In general, a material contract breach (i.e., a breach concerning an essential and inducing feature of the contract) may discharge the non-breaching party from performing on the contract while a minor or ancillary non-material breach generally does not discharge the non-breaching party (but may warrant monetary damages). Here, the SJC decided that the fraudulent recording of subcontractor payment did constitute a material contract breach.

The SJC’s holding in G4S Tech. LLC v. Mass. Tech. Park Corp. is significant for future construction contracts because it shapes different standards and effects for different categories of contractual terms. That is, to the extent a contractual term relates to the design or construction itself, a contractor is required to strictly and completely comply with such terms. The Court reasoned that strict compliance is required to ensure that the “construction itself is done safely and correctly according to design specifications.”7 However, if a contractor fails to strictly comply with a non-design / non-construction term then a court must analyze whether the non-compliance constitutes a material breach or merely a non-material breach and the effect thereof.

Moving forward, Massachusetts contract drafters, contractors, and owners should pay close attention to terms relating directly to the design or construction of a particular project. Interestingly, the SJC chose not to consider the consequences of contract provisions “that are subsidiary to or supportive of the design and construction, but do not directly involve the design and construction itself.”8 As such, future litigants may attempt to argue that particular provisions are merely “supportive” to a project’s design and construction and thus doesn’t require strict compliance. That being said, best practices for contractors remains the same – strictly and fully comply with all terms.
_______________________________________________________________________

1 G4S Tech. LLC v. Mass. Tech. Park Corp., 479 Mass. 721, 723 (2018).
2 G4S Tech, LLC, 479 Mass at. 721.
3 Id.
4 Id. at 723.
5 Id. at 733.
6 Id. at 734-24.
7 Id. at 731.
8 Id. at 732.

Who Benefits From Your Design Or Consulting Services Contract?

Andrew P. Selman | Vandeventer Black | December 21, 2018

In initially answering the question of who benefits from your design or consulting services contract, you might conclude that your contract benefits several parties. For example, a contractor “benefits” from the quality designs of the architect’s design consultant in performing its work even though it was not a party to the contract between the architect and the design consultant. Similarly, an owner of a project “benefits” from the design consultant’s work because the owner enjoys the finished product of the project. Depending on the project, perhaps even the public at large may “benefit” from the work that results from the contract.

But can these same parties make a breach of contract claim against you if something goes wrong and they don’t enjoy a benefit they were anticipating?

There are of course many factors that go into answering this question, and each situation is unique, so you should consult with an attorney to get an answer specific to your case.

For example, one factor to consider is whether the party bringing the claim is a “third-party beneficiary” of the contract. A third-party beneficiary can generally make a breach of contract claim against one of the parties to the contract—even though it itself was not a party to the contract—because the contract was intended to benefit that individual or entity.

However, just because a party “benefits” from your contract in the general sense of the word does not mean that that same party is a third-party beneficiary of the contract under the law. Broadly speaking, a third-party beneficiary under the law must prove itself as an intended beneficiary and not just an incidental beneficiary.

What this showing looks like varies from state to state. In Virginia, for example, the parties to the contract must have “clearly and definitely intended” the contract to confer a benefit on the third party. In West Virginia, by contrast, a party must show that the contract was made for its “sole benefit” before it can be considered a third-party beneficiary and make a claim under the contract. As a result, a claim may be viable in one state but not in another. For example, in Virginia the owner does not have a third-party beneficiary cause of action against a design-build designer. In North Carolina, the law provides such a third-party remedy.

The possibility of a third-party beneficiary being able to make a breach of contract claim demonstrates why it’s important to work with an attorney when possible while drafting and entering into agreements to properly assess who you may be liable to—or who you can seek damages from—in the event of a contract breach. Additionally, different legal principles apply to obligations separate from those arising under contract law that are also important to consider.

Allocation of Risk in Construction Contracts – 2018 Update

Ellis Baker, Luke Robottom and Anthony P. Laver | White & Case | December 14, 2018

Risk in construction contracts

‘Risk’, in a project delivery context, can be defined as ‘an uncertain event or set of circumstances that, should it occur, will have an effect on the achievement of one or more of the project’s objectives’.1 Risk exists as a consequence of uncertainty, and, in any project, the exposure to risk produced by uncertainty must be managed.

Construction projects are often complex, highly technical and of high value, and can have construction periods that may span a number of years. Common risks prevalent in construction projects include weather, unexpected job conditions, personnel problems, errors in cost estimating and scheduling, delays, financial difficulties, strikes, faulty materials, faulty workmanship, operational problems, inadequate plans and specifications, and natural disasters.3 Projects will also have additional specific risks, dependent on the nature of the project and its surrounding circumstances.

Although the volume and nature of contractual documentation for a construction project will vary as a consequence of the nature of the project, its scale and the procurement methodology adopted,4 a construction contract may be simply described as a contract between a contractor and an employer whereby one person (the contractor) agrees to construct a building or a facility for another person (the employer) for agreed remuneration by an agreed time.5 A construction contract will include a compact of rights and obligations6 between the parties by which the parties pre-allocate responsibilities between themselves in respect of certain risks that may transpire during the contract’s execution. In doing so, the parties define the impact of such risks on the three key elements of the construction: the product or facility that is to be constructed by the contractor, the time at which the product or facility must be completed by the contractor and the amount the employer is obliged to pay the contractor. The collective allocation of such risks in a construction contract represents its ‘risk allocation’.

 

Pursuit of a ‘fair and equitable’ allocation of risk

Typically, in preparing the contract document bid package, the employer will be in a position to decide on its intended risk allocation. While there may be, in such circumstances, a temptation to allocate major risks to the contractor, this must be tempered by an understanding of the adverse consequences of unilaterally assigning risk where doing so may preclude the submission of bids or result in such an increase in cost that the project is no longer financially viable.7 Improper risk allocation may also result in prolongation of construction completion times, wastage of resources and increased likelihood of disputes. As Shapiro states, ‘proper risk identification and equitable distribution of risk is the essential ingredient to increasing the effective, timely and efficient design and construction of projects. If the parties to the construction process can stop thinking in an adversarial manner and work in a cooperative effort towards obtaining an equitable sharing of risks based upon realistic expectations, the incidence of construction disputes will be significantly reduced.’8

While it is possible for parties to negotiate the terms of a construction contract individually, the possibility of unwanted variance and scope for abuse of bargaining power on both sides has led to a number of standard form contracts being developed by various entities, and it is now common in major projects for one of these standard forms to be used as the basis for the final construction contract.9 One of the pervasive features of standard form contracts is an attempt to produce a ‘fair and balanced’ allocation of risk.10 The rationale for pursuing this is that doing so will provide the best chance of successful project delivery. Echoing Shapiro, Lane notes that, ‘[a] contract which balances the risks fairly between a contractor and an employer will generally, in the absence of bad faith, lead to a reasonable price, qualitative performance and the minimisation of disputes.’11

Abrahamson suggests that to achieve a fair and equitable allocation of the risks inherent in construction projects, a risk should be allocated to a party if:

  • the risk is within the party’s control;
  • the party can transfer the risk, for example, through insurance, and it is most economically beneficial to deal with the risk in this fashion;
  • the preponderant economic benefit of controlling the risk lies with the party in question;
  • to place the risk upon the party in question is in the interests of efficiency, including planning, incentive and innovation; and/or
  • the risk eventuates, the loss falls on that party in the first instance and if it is not practicable, or there is no reason under the above principles, to cause expense and uncertainty by attempting to transfer the loss to another.12

Commenting on this, Bunni notes that, while the principle of control of a risk is a powerful method in the determination of risk allocation, it is not comprehensive and other principles must be utilised to address adequately the allocation of risk in a construction contract.13 For example, ‘acts of God’ or ‘force majeure’ cannot be controlled by either party, and, instead, the consequences of such risks must be assessed and managed. Consequently, Bunni proposes that the following four principles are used for allocating risks in construction contracts:

  • Which party can best control the risk and/or its associated consequences?
  • Which party can best foresee the risk?
  • Which party can best bear that risk?
  • Which party ultimately most benefits or suffers when the risk eventuates?

The question of what is a ‘fair’ risk allocation is, ultimately, a subjective one; in deciding how it wishes to procure a project and the way it seeks to allocate risks, an employer will need to weigh up the theoretical efficiency of the risk allocation with political and market dynamics and the needs of the particular project.