Sabo & Zahn 233 S. Wacker Dr.

Suite 8620 Chicago, IL 60606

312-655-8620 312-655-8622 fax
Http://www.sabozahn.com

Sabo & Zahn

A t t o r n e y s a t L a w

Liquidated Damages Clauses in Construction Contracts

onstruction contracts often contain liquidated damages provisions. This article will give an overview of such provisions and contrast them with penalty and bonus clauses.

Assume that you are an owner who hires a general contractor to construct your new strip shopping center. The contract requires that construction be substantially complete by July 1 so that the tenants can begin their build-outs. You know that if the contractor delays the completion date, it will cost you money. If your contract is silent on this issue, you will likely be entitled to actual damages that result from the contractors delay. You will need to prove two things: that the contractor was at fault for the delay and the amount of the resulting actual damages. While the rst of these, the fault issue may or may not be difcult to prove, the damages that result will almost certainly be difcult. Courts (and many arbitrators) will not accept speculative damages. Some costs, such as interest paid to lenders, real estate taxes and the like, will be easy to prove once you know the amount of compensable delay. The real damages, however, will likely be in the form of softer costs. You might have a lease with your restaurant tenant that gives you a percentage of the restaurants gross income above a certain amount. The delay means you will lose a part of that income. Especially if the restaurant is a new business, it may be difcult or impossible to convince a court that your projections of income are anything more than guesswork. There is a way that you can short-circuit all of these proof issues: a liquidated damages clause. At the time that the contract is formed, you make a good faith effort to estimate all of the damages that you will suffer in case of a delay. You convert this to a daily cost and you have a provision something like the following:
FAILURE TO COMPLETE THE WORK ON TIME. It is mutually agreed by and between the parties hereto that time is of the essence and that in the case of the Contractors failure to complete the contract within the time specied and agreed upon, the Owner will be damaged thereby; and because it is difcult to denitely

This article is not legal advice. Consult with an attorney familiar with the law in your area.

Sabo & Zahn 233 S. Wacker Dr. Suite 8620 Chicago, IL 60606
312-655-8620 312-655-8622 fax
Http://www.sabozahn.com

ascertain and prove the amount of said damages, inclusive of expenses for inspection, superintendence, and necessary traveling expenses, it is hereby agreed that the amount of such damages shall be the liquidated sum of One Thousand Three Hundred Dollars ($1,300.00) per calendar day for every days delay in nishing the Work in excess of the number of working days prescribed; and the Contractor hereby agrees that said sum shall be deducted from monies due the contractor under the contract or if no money is due the Contractor, the Contractor hereby agrees to pay to the Owner as liquidated damages, and not by way of penalty, such total sum as shall be due for such delay, computed as aforesaid.1

Note that the clause above indicates that the amount being withheld is not a penalty. Many people want to insert a dollar amount for daily damages that is high enough to encourage the general contractor to timely nish the project. This dollar amount is often much larger than the actual daily damages the owner will suffer. Courts will reject this as an illegal penalty provision. There must be an attempt to reasonably anticipate the total amount of actual damages the owner will suffer if the project is late. This amount need not be accurate to the penny, it just needs to be in the same ballpark and based on a reasonable estimate. The owner should keep notes of how the amount was arrived at in case of a challenge at a later date. One court described the test that would be employed as follows:
Whether the forfeiture provision imposed a penalty, or provided for liquidated damages, is to be determined from the language and subject matter of the contract, the evident intent of the parties and all the facts and circumstances under which the contract was made. The most important facts to be considered are whether the damages were difcult to ascertain, and whether the stipulated amount is a reasonable estimate of probable damages or is reasonably proportionate to the actual damage sustained at the time of the breach.2

This article is not legal advice. Consult with an attorney familiar with the law in your area.

Naturally, both parties must agree to the liquidated damages provision in the contract. If one party is unsophisticated, such as a consumer or homeowner, and the liquidated damages provision is inserted by the more sophisticated party, a court may take a harder look at it. If the actual damages that will be suffered are fairly easy to establish, it is probable that the liquidated damages provision will not be effective. It is only if proof of these damages would be difcult or impossible to establish that such a provision may be enforceable. If you are involved in a contract where a liquidated damages provision is included, pay particular attention to it. If it is inserted for you or

Sabo & Zahn 233 S. Wacker Dr. Suite 8620 Chicago, IL 60606
312-655-8620 312-655-8622 fax
Http://www.sabozahn.com

your clients benet, you need to make sure it meets the requirements outlined above. This is an area where the advice of competent counsel familiar with the applicable jurisdiction is important.

Werner Sabo, FAIA, CSI James K. Zahn, FAIA, CSI

Endnotes: _____________________________________
1. Adapted from Associated Engrs & Contractors, Inc. v. State, 58 Haw. 187, 567 P.2d 397 (1977). 2. Morgen & Oswood Constr. Co. v. Big Sky of Montana, Inc., 171 Mont. 268, 557 P.2d 1017 (1976)

This article is not legal advice. Consult with an attorney familiar with the law in your area.