Issues Impacting Enforceability of Liquidated Damages in Construction Contracts

Luke Tompkins | Ward and Smith

Liquidated damages provisions are common in construction contracts to guard against damages that the owner or a contractor might suffer if a project is delayed beyond the completion date set forth in the contract.  These provisions appear in both public and private construction contracts.  Oftentimes, the owner of a construction project will include a liquidated damages provision in the prime contract with the general contractor.  The provision might state, for example, that if the project is delayed beyond the required completion date, the owner may assess against the general contractor liquidated damages in the amount of $1,000.00 per day until the project is complete.  The general contractor, in turn, will likely include a similar clause in its subcontracts passing along the risk of liquidated damages to its subcontractors if delays to the completion of the project are caused by the acts or omissions of the subcontractor.

Liquidated damages provisions are helpful because they establish the damages for construction delays at the outset of the project and eliminate the need to prove actual damages.  The party whom the liquidated damages clause benefits need only prove that the performing party delayed completion of the project to be entitled to recover the amount of damages listed in the contract.  In the absence of a liquidated damages provision, to recover damages for delay, an owner or contractor has to prove both that the contractor delayed the project and the actual damages that were caused by the delay.  Demonstrating actual damages is a difficult task that requires detailed proof that ties the loss to the period of undue delay with reasonable certainty.  Thus, being able to rely on liquidated damages for delay provision can be quite useful.

Liquidated damages clauses are generally enforceable, but most courts will not enforce a liquidated damages provision if (1) it constitutes a penalty as opposed to a reasonable estimate of the actual damages likely to be incurred due to delay, or (2) the party benefitting from the liquidated damages clause is responsible for a portion of the delay to completion of the project and the contract does not provide for apportionment of damages in the case of mutual delays.

I. Liquidated Damages vs. Unenforceable Penalty

North Carolina courts recognize a two-pronged test for determining whether liquidated damages are enforceable or constitute a penalty: (1) the damages from the breach of contract must be difficult to ascertain as of the time the parties entered the contract; and (2) the amount of damages stipulated must either be a reasonable estimate of the damages which would probably be caused by a breach or reasonably proportionate to the damages actually caused by the breach.  If the party disputing liquidated damages can prove either that actual damages were not difficult to ascertain or that the liquidated damages were not a reasonable estimate of actual damages and were not reasonably proportionate to the actual damages, the liquidated damages provision will not be enforced.

To show that damages were not difficult to ascertain, the party opposing liquidate damages has to show that there was a clear, objective basis for measuring all aspects of the actual damages that might result from the breach.  This is an extremely steep challenge in the context of liquidated damages for delays to construction projects.  First, North Carolina courts give substantial weight to stipulations by the parties in the contract that damages are difficult to ascertain.  Therefore, if the contract includes a clause stating that both parties agree the measure of damages that will result from project delays is difficult to ascertain, this will usually suffice to demonstrate that damages were in fact difficult to ascertain.  Second, courts often find that damages are difficult to ascertain when the project at issue is complex or involves a large undertaking, as is often the case with construction projects.  Lastly, delays in the completion of construction projects generally bring in to play many potential items of damages, including lost profits due to not opening the completed project on time, continued costs associated with operating other facilities that the project was meant to replace, increased costs of construction, etc.  Thus, it is unlikely that the party opposing liquidated damages for delays on construction projects will be able to show that damages were not difficult to ascertain at the time of contracting.

To demonstrate that liquidated damages are not a reasonable estimate of actual damages and that they are unreasonably disproportionate to actual damages, the party opposing liquidated damages must show that there was no reasonable attempt to estimate damages prior to contracting and that liquidated damages are shockingly excessive when compared to the actual damages suffered and the overall value of the contract.  As with the first prong, courts will generally defer to the parties if the parties stipulate that the amount of liquidated damages is a reasonable estimate of the damages that will likely result from delays to project completion.  If such a stipulation exists, this will be difficult to overcome, so contractors and subcontractors should refuse to sign such a stipulation if you believe the amount of liquidated damages is unreasonable.

Next, because liquidated damages are meant to approximate actual damages, courts will consider whether the liquidated damages amount is based on a reasonable estimate of actual damages made by the owner or contractor, or whether the liquidated damages amount was simply a random arbitrary amount.  Lastly, the court will look to whether liquidated damages are shockingly disproportionate to actual damages.  Courts have held that liquidated damages twice the amount of actual damages were reasonably proportionate to actual damages.  Thus, the party opposing liquidated damages will need to show that liquidated damages far exceed actual damages to succeed in having them ruled an unenforceable penalty.

In conclusion, contractors or subcontractors opposing liquidated damages for delays to construction projects face a difficult task in demonstrating that a liquidated damages clause is an unenforceable penalty.  It is nearly impossible to show that delay damages were not difficult to ascertain at the time of contracting.  However, if the contractor or subcontract can show that the liquidated damages amount was an arbitrary amount that far exceeded actual damages, a court may conclude that the liquidated damages constitute an unenforceable penalty.  On the other hand, owners and contractors can likely avoid having liquidated damages for delay clauses overturned as unenforceable penalties if the liquidated damages amount reflects a sincere attempt to estimate actual damages and their contract includes stipulations that actual damages are difficult to ascertain and that the liquidated damages amount is a reasonable estimate of actual damages.

II. Mutual or Concurrent Delays by Contracting Parties

Under North Carolina law, it is clear that the party benefitting from a liquidated damages provision cannot recover liquidated damages if it is responsible for all of the delays to the project.  In addition, North Carolina law states that liquidated damages are unenforceable if the party benefitting from the liquidated damages was itself responsible for a portion of the delays to project completion unless the contract contains a clause providing for apportionment (i.e. division) of liquidated damages in the case of mutual delays.  This rule, which I’ll refer to as the “Non-Apportionment Rule,” was recognized by the North Carolina Supreme Court in 1967.  Under the Non-Apportionment Rule, if the owner or contractor whom the liquidated damages clause benefits is responsible for any amount of the delays to project completion, they cannot recover liquidated damages unless the contract authorizes project delays to be apportioned between the parties so that liquidated damages can be assigned to the contractor or subcontractor based on the delays they are responsible for.  In other words, an owner’s or contractor’s responsibility for a portion of the project delay can result in not being able to recover liquidated damages for delays caused by the performing party.  Notably, there is a trend among other jurisdictions away from the Non-Apportionment Rule because some courts have found it to be overly harsh.  North Carolina’s Non-Apportionment Rule, however, has never been overruled and was applied by the North Carolina Court of Appeals as recently as 2007. 

Based on the Non-Apportionment Rule, mutual delays can serve as a basis for complete avoidance of liquidated damages where the contract does not authorize apportionment of liquidated damages.  Thus, parties seeking to avoid or enforce liquidated damages should be aware of the Non-Apportionment Rule.  Owners or contractors seeking the benefit of liquidated damages provisions should consider including a provision in your contract for apportionment of liquidated damages in the case that both parties are responsible for delays (i.e. there are mutual or concurrent causes of delay).  If an apportionment clause is included in the contract, the performing party should negotiate for any apportionment of delays to be administered by a neutral third party, so as to eliminate any bias in dividing the delays among the parties.  If it is not included, the performing party should seek to prove mutual delays as an avenue to avoid liability.  In either case, both parties should be sure to document and collect evidence of all delays which you contend the owner, contractor, or a subcontractor has caused to the project as you may need this evidence to either establish your right to liquidated damages or to escape or minimize your liability for liquidated damages. 

Conclusion

In conclusion, liquidated damages clauses provide a helpful remedy to the party harmed by delay in circumstances where calculating actual delay damages is difficult.  Liquidated damages, however, will not be enforced if they do not reflect a reasonable estimate of actual damages and are grossly excessive in comparison to actual damages.  Additionally, unless the contract provides otherwise, liquidated damages for delays will not be enforced by the courts if the party seeking enforcement is responsible for some of the delay at issue.  Participants in the construction industry should keep these issues in mind when negotiating and entering into construction contracts.

How Will Today’s Pandemic Impact Tomorrow’s Construction Contracts?

Levi W. Barrett, Nathan A. Cohen and Mark A. Snyder | Peckar & Abramson

The emergence of COVID-19 has created a new set of challenges in the already complex world of negotiating construction contracts.  In the pre-COVID-19 era, general contractors, construction managers and those negotiating on their behalf, needed to balance a variety of fairly well-established legal risks and exposures and commercial realities with the need to maintain a positive relationship with their counterparty.  While many are rightfully concerned with addressing the impacts of COVID-19 to their on-going projects, those negotiating new contracts now are undoubtedly cognizant that they are negotiating in the midst of an unpredictable future that is tipping the historical negotiating balance.  The following presents some crucial areas to focus on when negotiating and drafting your contracts in this new era.

Contract Terms Through the COVID-19 Lens

Contractors should examine proposed new contracts carefully to identify rights that afford COVID-19 protections and identify contractual obligations that create COVID-19 commercial risks.

Specific attention should be paid to those sections relating to force majeure/excusable delay, emergencies, changes (including changes in law), contingency, suspension and termination, site investigation as well as all representations and warranties.  The paramount concern in examining these provisions is to ensure that they not only entitle the contractor to relief for those unknown events, emergencies and changes, but that they also contain sufficient entitlement for the contractor to obtain both time extensions  and financial compensation for unknown impacts of a known event – the COVID-19 pandemic.

For projects that may have been bid before COVID-19, contractors may be experiencing internal and external commercial pressures to ignore potential COVID-19 impacts and hastily sign the contract.  Others may have considered withdrawing their bid or submitting a revised price that considers the increase in costs related to COVID-19 resulting from government mandates, unpredictable labor markets, potential project-shutdowns and other impacts to a project.  While the latter choice may appear attractive, it too comes with risk.  Estimating a job by assuming that the current conditions will remain in-place for the full duration of a complex, long-term, construction project may not be a commercially viable option given the risk of numerous changes the future may hold.

Items of Particular Concern

I. COVID-19 Impacts to Price and Schedule

Construction contracts often entitle the contractor to extensions of time for excusable delays, but not an equitable adjustment of the contract price.[1]  Contractors should look to adjust excusable delay provisions or include new specific language to provide for entitlement to additional time and compensation associated with COVID-19 impacts.  If compensation terms cannot be negotiated into the contract, this risk will need to be priced, which, as discussed above, may be a difficult task.

Contractors should be especially concerned with risk-shifting provisions which make the contractor responsible for “anticipated” events or impacts that the contractor “should have” known about.  Such broadly phrased risk-shifting provisions may saddle the contractor with an unwieldy burden.  The question of what a contractor should “foresee” is inherently difficult to answer.  When this language cannot be removed, it should be limited to the extent of “reasonable” foreseeability.  For contracts that are being negotiated today, contractors should be mindful that the cause of tomorrow’s delays may actually flow from COVID-19 events which commenced prior to the execution of their agreement.  When confronting COVID-19 delay and impact claims owners can be expected to contend that these impacts were foreseeable, even if not fully quantifiable.  Contractors need to take appropriate steps to ensure that their contracts are clear, and to the largest extent possible, cover impacts flowing-out of the present pandemic and any future resurgences of COVID-19 or similar outbreaks.

Alternatives to this kind of language are manifold and include from building COVID-19 allowances or contingences into the contract to including concise language detailing the specific COVID-19 related risks that the contractor has built into its price (as distinguished from those that will entitle it to an adjustment from the owner).  Contractors may consider categorizing COVID-19 related impacts into two buckets – the known and the unknown and factoring those presently known impacts of COVID-19 into their price and schedule. For example, such known items may include social distancing requirements, workforce limitations, temperature screening, personal protection equipment, as well as performance delays and costs that arise out of the cumulative impact of these new measures. Next, the contractor needs a mechanism to obtain price and schedule relief for the presently unknown impacts of COVID-19.

Further, since the outbreak of the pandemic, governmental agencies across the country have imposed new rules and restrictions on contractors to protect workers and the public and to prevent the spread of the disease.   These rules and requirements have changed repeatedly as this pandemic has unfolded and construction contracts do not always provide clear entitlement to relief for a change in law.  For example, AIA A201 – 2017 Section 3.7 requires the contractor to comply with all laws applicable to the work without regard to when such law(s) were enacted.  Therefore, the contractor would be well served to revise such language to include an entitlement to time and financial compensation for any changes in law, and expressly those related to COVID-19.

II. Contractor Representations

In many construction contracts, the contractor provides broad and unqualified representations that it will be able to furnish the materials and labor required to the complete the work, often within the defined contract time.  This can be a difficult representation to make in the current market and should be appropriately qualified to consider the uncertainty that exists in current labor markets and the potential for supply chain disruptions that are outside the contractor’s control.  Additionally, ensuring that the contract provides for entitlement to equitable adjustments of time and contract price for COVID-19 related impacts will assist with mitigating this risk.

Contractors should also be mindful of how the various provisions of a contract interact with one another.  For example, an excusable delay provision with a catch-all for causes of delay outside of the contractor’s reasonable control may be partially undermined by a broad representation that the contractor has investigated the project, carefully reviewed the contract documents, and assumes all risks and hazards associated with labor availability, site safety, material availability, market conditions and site accessibility.

While some owners now include explicit COVID-19 risk transfer provisions requiring the contractor to assume all risks, others have relied on more surgical language changes to subtly shift COVID-19 risks to the contractor.  Thus, it is important that all clauses that relate to COVID-19 impacts are harmonized.

III. Indemnities, Insurance and Waivers of Consequential Damages

No discussion of construction contracts would be complete without a nod to indemnities and waivers of consequential damages.  While indemnity language differs widely from project-to-project, and a general discussion about the myriad variations is beyond the scope of this article, indemnity issues affected by risks related to COVID-19 should be treated with special consideration.  Contractors are well advised to carefully examine contractual indemnity language for risks arising from or related to COVID-19 related exposures and coordinate the indemnity with their insurance coverage.  For example, to what extent might COVID-19 be included as a covered claim for “bodily injury” as some insurers have now begun to exclude coverage for communicable diseases.  As coverage and policies varies from company-to-company and at times from project to project for the same company, contractors should consult with legal and insurance professionals to assess these provisions.

Consequential damages waivers are always critical protections for contractors; and should now be tailored to ensure they address COVID-19 related risks.  A failure to secure an effective consequential damages waiver creates significant exposure on any construction project, exposure that is made exponentially greater by the long list of potential damages that may arise from COVID-19.  For instance, a contract by which a contractor has exposure to delay damages or has a broad obligation to comply with all laws and regulations applicable to the project (including those enacted after execution of the contract),[2] would potentially create a heightened risk of liability in this current COVID-19 environment.

Conclusion

As this pandemic continues to impact the construction industry, we expect new strategies to be developed as contractors and owners work together to address and apportion the risks of tomorrow’s construction projects.  As part of that effort, contractors will be best served to bear in mind potential impacts to cost and schedule, the scope of their representations and obligations, and ensuring that all such clauses throughout the contract are properly harmonized.   The results of  a sensible and carefully formulated risk allocation effort should be written into prime contracts and contracts with trade contractors.


[1] See, for example, AIA A201 – 2017 Section 8.3.1 and ConsensusDocs 500 Section 6.3.1

[2] See, again, for example AIA A201 – 2017 Section 3.7

Court Recognizes Day-to-Day Changes Are Compensable Despite Contractual Waivers

Matthew DeVries | Best Practices Construction Law

It happens all the time! The owner-contractor agreement contains a “no damages for delay” clause; a clause requiring that all changes be in writing before work is performed; and a clause requiring partial lien waivers and releases with each periodic payment.  And yet we see a claim for delays and extras filed at the end of a construction project that challenges these very contract provisions.

The Court of Appeals of North Carolina recently grappled with this exact scenario in Gamewell Mechanical, LLC v. Lend Lease Construction (Sept. 1, 2020) (PDF).  The project involved the new construction of three buildings in Durham, North Carolina.  The mechanical subcontractor filed suit against the prime contractor for $2.7m for breach of contract for nonpayment, claims for delay damages and enforcement of its lien rights.  The prime contractor argued that subcontractor’s claim should be limited to its contract balance of approximately $500k in retainage. Ultimately, the trial court awarded the subcontractor more than $800k for its claims.

On appeal, the contractor argued that the award should have been limited to the $500k in retainage.  By executing lien waivers and releases with each periodic payment, the contractor argued, the subcontractor had waived all of its claims other than retainage. The parties’ lien waiver contained language where the subcontractor could have reserved disputed claims, but the subcontractor never did so. The appellate court held that the trial court properly rejected a majority of the subcontractor’s claims that were subject to either the “no damages for delay” clause or the period lien waivers.

Notably, the trial court made a distinction for “day-to-day” or “daily” changes in the field for extra work, which was credited by the appellate court as follows:

[I]t is undisputed that there were delays, numerous Change Orders issued, re-sequencing, and coordination issues occurring throughout the project. Given the daily problems that arose as a result of these issues, [subcontractor’s] failure to reserve claims regarding the day-to-day miscellaneous items done in the field at the direction of [contractor] is not a material breach-of-contract. . . . The waiver and release documents submitted with each pay application could not cover claims not readily apparent due to daily changes on the job.

The appellate court held that competent evidence supported the trial court’s decision on each of these points.

A New Exception?

The opinion is notable because of the court’s findings that are highlighted in bold and underline above. When I read the court’s opinion, I started to think: (1) Is there now a “daily changes” exception to lien waivers and releases? (2) Are day-to-day miscellaneous items compensable even where a party fails to reserve their rights on these type of  cumulative claims? According to the court in Gamewell Mechanical, the answers these questions is yes. It would be interesting to see what other courts have reached similar conclusions.

Contract Clauses Limiting Damages

Stanley A. Martin | Commonsense Construction Law

The NH Supreme Court has enforced contract clauses waiving consequential damages and limiting liability. It has also noted that tort claims asserted when the underlying transaction was based on a contract will be barred by the economic loss doctrine.

The plaintiff was an engineering service firm that works with advanced composite materials for Department of Defense clients. The defendant was an IT service provider. The engineering firm had a problem with a drive in one of its servers, and the IT company was brought in to resolve the issue. Unfortunately, the engineering firm lost data because the IT company had “failed to properly back it up.”

The engineering firm sued for the cost of “massively expensive” testing in order to recover the lost data. It brought claims against the IT company for breach of contract and negligence. The IT company moved to dismiss the costs of testing and any other damages that were not direct damages, and also sought to dismiss the negligence claims. The trial court dismissed the consequential damages, and held that the negligence claim was barred by the economic loss doctrine.

The NH Supreme Court upheld the trial court decision on both issues.

Recognizing that the line between direct and consequential damages “is not capable of exact determination,” the NH high court nonetheless held that the cost of recreating lost data, and the cost of lost business claimed as a result, were consequential damages. Thus, those damages were barred by the parties’ contract.

Speaking more generally, the NH Supreme Court also noted: “Courts cannot improve the terms or conditions of an agreement that the parties themselves have executed or rewrite contracts merely because they might operate harshly or inequitably.” Courts would only do so if the contract term “contravenes public policy.” No such public policy was present here.

Also, the NH court addressed the negligence claim that had been brought in tandem with the breach of contract claim. It noted that contract and warranty standards “are better suited than tort law” to address purely economic loss in the commercial arena. Thus, a contracting party would be barred from pursuing a tort claim unless that party “is owed an independent duty of care outside the terms of the contract.”

Finding no such duty, the court upheld dismissal of the negligence claim against the IT provider, and limited the engineering company to its direct damages. The case is Mentis Sciences, Inc. v. Pittsburgh Networks, LLC, 2020 N.H. LEXIS 155 (Sept. 22, 2020).

Recent Tennessee Construction Cases Regarding Effects of Unlicensed Contracting and “Time is of the Essence” Clauses in Contracts

Allison Wiseman Acker, Shayne R. Clinton, John W. Dawson IV, Brian M. Dodds, Jeff Gibson, L. Wearen Hughes and John S. Golwen | Bass, Berry & Sims

While neither of the recent cases discussed below establishes new law, they serve as good reminders of principles and requirements that can be important to participants in construction projects in Tennessee. The first case, Sifuentes v. D.E.C, LLC, addresses the effects on a subcontractor’s remedies of not being licensed as a contractor as required in Tennessee. The second case, Clark v. Givens, involves the effect of a construction agreement not containing a “time is of the essence” provision.

Unlicensed Subcontractor

Sifuentes v. D.E.C, LLC was a suit by an electrical subcontractor against a general contractor to recover amounts for breach of contract, quantum meruit (also called unjust enrichment), promissory estoppel, and promissory fraud. The trial court dismissed on summary judgment all claims because the subcontractor was not licensed as an electrical subcontractor as required in Tennessee and, thus, could not pursue those claims. On appeal, the Tennessee Court of Appeals ruled the quantum meruit claim should not have been dismissed, but otherwise affirmed the trial court’s judgment.

The court based its ruling primarily on case law in Tennessee related to the effects of a contractor being unlicensed and on Tenn. Code Ann. § 62-6-103, which limits recovery by unlicensed contractors to “actual documented expenses that can be shown by clear and convincing proof.” While disagreeing with the trial court’s reasoning that this provision creates a statutory cause of action for unlicensed contractors, the Court of Appeals said the statute limits the measure of recoverable damages for an unlicensed contractor, consistent with applicable law. Therefore, the claim for quantum meruit, which technically seeks the value of the benefit conferred on the other party when there is no enforceable express contract, was not barred by the subcontractor’s unlicensed status.

Time is of the Essence

Clark v. Givens involved claims between a residential homeowner and a contractor arising out of an oral contract for construction services. Among the issues involved on appeal was whether the trial court erred in dismissing the parties’ claims and rescinding the oral contract for the parties’ mutual mistake as to the time for completion. The Court of Appeals ruled the trial court erred, based on established case law that a party’s failure to complete a project within the time for completion does not constitute a material breach absent a provision in the contract making time of the essence.