By AIA Contract Documents
January 30, 2023
If you’re entering into a construction contract, ensure that you fully understand your exposure to liquidated damages. Liquidated damages provisions are included in many construction contracts as a way for the parties to define their risks in the event of a breach. Regardless of the stage that you are at in the contracting process, parties should have a firm grasp on their exposure to liquidated damages and what this provision represents in a contract.
Generally, liquidated damages provisions specify a predetermined sum for damages that must be paid by the breaching party. In construction contracts, liquidated damages provisions are often seen as a fee per unit of time in the event of a missed milestone, like substantial completion, final completion, or occupancy. The liquidated damages provision is typically expressed as a sum certain, per day, for each day that the milestone is not met. Liquidated damages will begin to accrue if a milestone is missed and will continue accruing until that milestone is achieved. For example, if the parties agree to liquidated damages in the amount of $1,000 per day for each day that the project has not reached substantial completion by an agreed upon date, then the liquidated damages continue to accrue at a rate of $1,000 per day until substantial completion is met. Additionally, parties may agree to a cap on liquidated damages and in that event, liquidated damages continue accruing until that maximum is reached.
The purpose of liquidated damages provisions is to allow the parties to agree on a reasonable estimate of damages that might be difficult or impossible to calculate. This type of provision can benefit both parties by defining risk, while avoiding the need to later calculate actual damages and prove those damages through the dispute resolution process. Both the calculation of actual damages and process to prove (and defend against) those damages can be very costly to both parties.
Liquidated damages provisions do not always simply stop at defining how to assess the damages. Contracting parties may explicitly agree as to how liquidated damages are claimed and recouped. For example, parties may agree that the liquidated damages amount can be withheld from progress payments, or instead, that the assessed sum must be asserted and recovered as a separate claim. By explicitly agreeing to a process for asserting a liquidated damages claim, both parties can have a better understanding of how to act, and what to expect, during the project. Failure to include a process for asserting a liquidated damages claim can cause ambiguity and lead to confusion and often, lawsuits.
In all, liquidated damages can provide clarity and reassurance to owners and contractors. It allows both parties to have a better understanding of their risk on the project, and the reassurance that damages will not need to be proved, in the traditional sense, during dispute resolution. Ideally, the parties should fully understand their exposure to liquidated damages, as well as the basis for assessing liquidated damages and how claims are asserted before the contract is finalized and work begins on the project.
AIA Contract Documents has provided this article for general informational purposes only. The information provided is not legal opinion or legal advice and does not create an attorney-client relationship of any kind. This article is also not intended to provide guidance as to how project parties should interpret their specific contracts or resolve contract disputes, as those decisions will need to be made in consultation with legal counsel, insurance counsel, and other professionals, and based upon a multitude of factors.