Construction contracting is extremely time-sensitive. If the project gets late for completion, the client will lose anticipated revenue and profit. In addition, the client may lose opportunities for future investments. Similarly, when projects are late to complete, contractors face additional financial burdens. For example, that is maybe for employing the field and office personnel for an additional period of time.
At present, the marketplace is very competitive. No clients or contractors can afford the cost of late projects. However, in every project, there is a risk of late completion. Therefore every client tries to shift at least part of the risk onto contractors. The common form of shifting the risk is providing a liquidated damages clause in the construction agreement.
Purpose of LD
The contractor’s obligation is to complete the works by the date of completion stated in the contract. If he fails to complete the work by that date and if there is an LD clause in the contract, the contractor is liable for LD to the client. As the name implies, this is to compensate the client for financial losses or additional expenditure incurred in the event that the contractor fails to complete the works by the agreed completion date. They are not intended as a penalty. The client or the consultant has to carry out a realistic pre-assessment to determine the level of liquidated damages before the issue of the bidding documents. And the amount must be stated in the bidding documents.
The legal principle behind the liquidated damages is that damages for breach by either of the contracting party may be liquidated. But it is only up to a reasonable amount compared to the anticipated or actual loss caused by the breach. It is unreasonable to fix large liquidated damages. In addition, it is unenforceable on grounds of public policy as a penalty.
Liquidated Damage is a sum agreeable by the client and the contractor in advance. The contractor has to pay this amount as damages if the contractor breaches the contract by failing to complete the work on time.
LD is enforceable if the amount fixed is a genuine pre-estimate. However, it must be judged at the time the contract is entered into, of losses like to arise from the anticipated breach.
In Sri Lanka, Clause 49 of ICTAD/SBD/1 gives the provisions for liquidated damages. In Sub Clause 49.1, it says the contractor shall pay liquidated damages to the client at the rate per day stated in the Contract Data. The period is for each day that is beyond the Intended Completion Date up to the actual completion date. In addition, it says the total amount shall not exceed the amount defined in the Contract Data. The client can deduct liquidated damages from payments due to the Contractor. However, the Contractor’s liabilities shall not affect due to the payment of liquidated damages.
According to Sub Clause 49.2, if the intended completion date mentioned in the contract data is extended after liquidated damages have been paid, the consultant can correct any overpayment of liquidated damages by adjusting the next payment certificate. The Contractor shall be paid interest on the overpayment, calculated from the date of payment to the date of repayment, at the rates specified in sub-clause 43.1.
Sample – Contract Data
(49.1) a) The liquidated damages for the whole of the Works shall be Rs: 1,000.00 per Day.
b) The maximum amount of liquidated damages for the whole of the Works shall be 10 percent of the Initial Contract Price.
Advantages of LD clause to Client
The tender document shows the amount of LD in advance. So it avoids the client having to calculate and prove the actual loss. It also concentrates the contractor’s mind on finishing the project on time.
Advantages to Contractor
In a tender situation, it fixes the contract price more certain. That is because then the Contractor can price the level of LD into his tender bid. Additionally, if the contractor thinks the project may go behind the schedule, the contractor can make a decision as to whether it would be preferable to hand the building over late and pay LD. Or else, is it worth to allocate more resources to the project and finish it on time.
Another advantage for the contractor is the level of LD specified is a ceiling for the amount for the damages payable. The client cannot later change the amount and recover an additional sum from the contractor even the client’s actual loss is greater than the LD stated in the contract.
LD clauses and penalties
It has long been the case that if a clause for LD has been included as a penalty for late completion, rather than a genuine pre-estimate of loss, then the courts will not enforce it. However, just because the level of LD specified in a contract is substantially higher than the loss actually suffered does not necessarily make the LD clause invalid as a penalty.
If the sum is “extravagant in amount in comparison with the greatest loss which could conceivably be provided to have followed from the breach”.
To take an extreme example, if the contractor is late in completing a project, and the client can satisfy the court that the amount specified in the contract for LD was a genuine estimate of likely loss, then the LD are payable by the contractor. Practically client deducts LD from future payments due to the contractor. The client can do this even when he suffers no loss.
Genuine pre-estimate of loss
The key is that client must be able to show that the figure in the LD clause is realistic. It must be a genuine estimate of the likely loss which the client would suffer if the contractor was late in achieving practical completion. If the contractor argues about the LD amount, the Client can preferably defeat it if he can show how he arrived at the figure in question, with calculations, projections, etc. The client may take into account factors such as loss of income and increased financing costs for these calculations. As stated above, the estimate needs to reflect the position at the time of the contract. It is not at the time when the claim arises.
LD and extensions of time
Building contracts almost invariably contain clauses entitling the contractor to an extension of the contract period in certain circumstances. For example, one reason may be the effect of exceptionally adverse weather conditions. In such events, the client may extend the date for practical completion by an agreed period of time. Therefore, the question of LD would not arise until the expiring revised date for practical completion.
Sometimes, a court may decide that the LD clause is unenforceable. However, this does not mean that the client is then disallowed from claiming damages from the contractor for the delay. The client would merely have to rely on his common-law right to damages for breach of contract. That is for the contractor’s breach of contract for failure to complete the project on time.
In some contracts, the sum of liquidated money is not established in advance in the contract. In such an event, the Court determines the amount after the breach occurs. That is termed as unliquidated damages.