Construction File: Liquidated Damages Clause
A liquidated damages clause will be enforceable where it represents a genuine pre-estimate of the damages an owner will likely suffer as a result of a contractor’s delay. However, where a liquidated damages clause is excessive and objectively unreasonable, it will likely be considered a penalty clause and will be unenforceable.
The courts in British Columbia have recognized that in some instances a breach of contract can give rise to damages which are difficult, costly and time consuming to prove and that it may be appropriate in these circumstances to utilize a liquidated damages clause. Following this approach, some owners have inserted detailed liquidated damages clauses into their tender and contract documents. These types of liquidated damages clauses tend to be drafted for the specific project in question and provide a formula for determining what the quantum of the liquidated damages may be. In so doing, the contractor knows its potential exposure in advance and may bid the project accordingly.
Other owners insert the same liquidated damages clause into most or all of their tender documents and contracts without having regard to the specific project being built. These liquidated damages clauses typically provide that the owner may deduct a specified amount (i.e. $500) per day for each day that the contractor fails to meet the agreed-upon completion date and also deduct all “out-of-pocket” costs incurred by the owner as a result of the delay. Notwithstanding the express terms of these types of liquidated damages clauses, it is likely that the specified per-day dollar amount is not a genuine pre-estimate of damages as it bears no relation to the construction issues surrounding the project. Further reference to undefined “out-of-pocket” costs makes determining and pricing potential exposure extremely difficult.
Other owners are moving away from liquidated damages clauses towards a damages recovery model not based on an express formula or even a specified per-day deduction; but rather, based on the concept of payment by the contractor of an amount equal to all costs and damages incurred by the owner as a result of the failure of the contractor to complete its work by the agreed upon completion date.
Over time, the courts have imposed limitations on what can be recovered by an owner as a result of delay(s) caused by a contractor. Courts generally restrict contractual damages to those which are directly caused by the breach of contract, or which were a reasonably foreseeable consequence of a breach of the specific contract in issue at the time the contract was entered into. In the face of these recovery rules, some owners insert clauses into tender documents and contracts designed to circumvent common law by giving notice to the contractor that damages that may not be recoverable under normal contractual principles are recoverable if the contractor is late in completing its work (e.g. indirect, consequential and incidental damages). These types of clauses give contractors no reasonable basis upon which to price the risk of late completion as there is no limit placed on what the owner can claim and potentially recover.
The insertion of liquidated damages and similar clauses in tender documents and contracts can increase bid prices and, depending on the precision in which they are drafted, may add price uncertainty. This may lead to inflated bid and contract prices which will not benefit an owner and may lead to a windfall for a contractor if there is no delay. Accordingly, before using a liquidated damages or similar clause, owners should seriously consider their overall benefit in the context of the construction project being built and, where damages may be difficult, costly and time consuming to prove, provide contractors with a precise mechanism for determining and pricing the risk.
BCCA wishes to acknowledgement Jenkins Marzban Logan for this article.