Delays in the construction business are simply par for the course. But for some projects, excessive setbacks can have a ripple effect downstream such as incurring extra project costs, missed business opportunities or a late start for other dependent activities. Sometimes these delays are unavoidable. Other times, they may be due to the contractor’s oversight. In these instances, it may be determined to be a breach of contract. This is where liquidated damages come in. Although no one wants to be in a situation to have to deal with them, it’s important to understand what they are, how they are calculated and what you can do to mitigate their occurrence in the first place.
What are liquidated damages?
Liquidated damages are the agreed-upon compensation owed to one party (most often the client) when the other party (frequently the contractor) doesn’t meet the timeline requirements, and is based on a forecast of estimated real costs and losses the first party would likely incur. This is set forth in a liquidated damages clause within the construction contract before the project begins.
How are they calculated?
Calculating such damages requires outlining a formula within the clause to arrive at what the agreed-upon compensation will be. But there’s actually no one standard formula for determining liquidated damages. Why? Because no two projects are exactly alike, nor are the ramifications of schedule delays universal across all builds. So how do you come up with the correct equation? Much will depend on the end use of the project. For example, if a contractor misses the deadline, a set monetary rate multiplied by the daily or weekly time beyond the completion date would be a starting point for determining the damages amount.
That seems straightforward, until you consider there are other costs to account for. This will vary by project and circumstance, but other reimbursable costs the client could collect from the contractor often include storage fees, loss of business income, loss of tenant rent, etc. Let’s say the project is a multi-use facility with numerous tenants lined up to move in. If the project is not substantially completed by the deadline, then lost revenue for the time those tenants would otherwise have been paying rent to the owner could be included in calculating compensatory damages. On top of that, contractors could be on the hook for paying for extra labor hours, as well as for things like extended equipment rental.
These are not meant to be a penalty, but rather compensation for losses incurred by the client as a result of the contractor not meeting the contracted deadline(s). At the end of the day, it’s about actual, true damages; it’s not supposed to be used as punishment through excessively high financial consequences. In fact, if it winds up in court for breach of contract, a judge can throw out the case if it’s found the client was using the damages clause as a sort of penalty. The client must be able to demonstrate verifiable loss in order to collect on the damages.
These monetary damages come out of the contractor’s project price, which could put a serious ding in their ROI. But determining how the damages are calculated is not unilaterally decided by the client. To help head off the potential of litigating a dispute in court, both sides arrive at a mutually agreeable set of terms when the damages clause is being written up before the project even starts, and both assign acceptable levels of responsibility.
Advantages of a liquidated damages clause
- The owner gains the security and assurance that every effort will be made to complete the project on time.
- The contractor reduces their risk of breaching the contract by negotiating for realistic timelines — especially when backed by historical benchmarks. To further protect the extent of their liability, the contractor may wish to stipulate that they are not on the hook for delays due to events or situations beyond their control such as hiccups in the supply chain, natural disasters or extreme weather conditions. If consequential delays do occur, it could wind up being much more economical for the contractor to have such a clause in place.Â
- For both parties, liquidated damages clauses are far more preferable to a drawn-out, expensive – and often lengthy – litigation process to collect on those actual damages.
Avoiding or reducing their impact
By taking steps to reduce their occurrence altogether or to at least mitigate their degree of severity, you can create a proactive risk-avoidance blueprint that aims to better preserve your ROI and your peace of mind.
InEight’s comprehensive estimating software can help take the guesswork out of your project bids and ongoing estimates with real-world forecasting scenario capabilities that provide insights into a true picture of your progress.Â
And that comes in handy when those clauses are first being drawn up. You’ll not only gain the level of control you need to head off costly mistakes that could lead to a liquidated damages claim needing to be filed, but you’ll also gain greater certainty that the project can be constructed within the established budget and timeline.
