What are liquidated damages?

What are liquidated damages?

If I asked my clients to name their biggest project risk in the last 12 months, 10 out of 10 of them would say “managing the program”. It has become next to impossible to get materials or labour on time. So now, everybody is talking about liquidated damages. But what are liquidated damages?

Many of you will have experienced a situation like this: you signed a contract 18 months ago. The initial program bore only the flimsiest relationship with reality, even without the current supply delays and labour shortages. Now, the project has been plagued by delays. By the time trade contractors started appearing on site, any tenuous hold that the contract and project managers had on the program had faded into oblivion. Everyone’s given up asking for revised programs. Subcontract teams are working to the two-week look ahead – if there is one.

Time marches on and now practical completion (PC) is looming. The main contractor starts haranguing subbies to bring teams to the site, but when they get there their areas aren’t ready so they go to another job. Tensions flare. Threats get thrown around about show cause notices and liquidated damages (LDs).

That’s when you might ask, what are liquidated damages, and what makes them enforceable? I hear some fairly outlandish ideas about this and I want to set the record straight.

What are liquidated damages, and why would anyone agree to them?

A failure by the contractor to complete the works by the agreed deadline is a breach of contract. In legal terms, breach of contract entitles the injured person to damages, calculated as the actual (proven) loss caused by the delay to completion.

LDs are damages imposed on a contract party at a pre-agreed, fixed (i.e., liquidated) sum or rate, set at the time the contract is entered into, which must be paid if some contract obligation is not satisfied. In construction, this is typically the contractor’s obligation to deliver the project by a set date.

So, in construction LDs usually take the form of a daily rate, to be paid by the contractor to the principal (or head contractor) for each day that delivery is delayed beyond the agreed deadline for completion.

The doctrine of LDs has benefits for both sides. The advantage to the principal is that it does not have to prove its actual damages, which can be so costly as to defeat the purpose of taking legal action. The advantage to the contractor is that it may be able to negotiate a rate lower than the actual loss, including a cap on the exposure.

When will LDs be enforceable?

A liquidated damages clause connected with delayed performance will be enforceable where:

  • the agreed sum is a genuine and reasonable pre-estimate of the losses which the principal is likely to suffer if the contractor fails to perform by the agreed date for completion; and
  • the contract stipulates a firm, agreed delivery date. 

If the liquidated sum is not a genuine pre-estimate, it is said to be a “penalty”, which is not enforceable under Australian contract law. I often see main contractors attempting to “back-to-back” subcontractors on the LDs. In my view, this is unlikely to be a genuine estimate of the cost of a subcontractor finishing late, even if they’re a finishing trade.

Generally, a right to liquidated damages can only be enforced when performance is complete and where contractual procedures have been strictly followed. Lately I have seen some main contractors attempting to claim LDs during the course of the project, perhaps after certain milestones, and also where the program descended into chaos a year or more ago and the notion of a Date for PC has been completely lost. In the absence of agreed milestones with connected LDs stipulated in the contract, I think it is unlikely that a court would support this kind of action.

It’s important to understand what the contract says about time

Time is critical to making money in construction, so usually “time is of the essence” in construction contracts. That means it’s really important that the parties meet any milestones in the contract, and if they don’t, the other party may be entitled to terminate, or get the benefit of other entitlements (like LDs).

Construction contracts typically specify the date for completing the works (aka, the “Date for PC”). If the contract doesn’t specify a date for PC, or where the requirement to complete by that time has been set aside, the law will imply an obligation for the contractor to finish in a reasonable time. What is “reasonable” is influenced by the circumstances of the project.

Each party is entitled to the full amount of any stipulated time to perform. Unless the contract says something different, neither party can insist that the other finish their scope early (e.g., by way of a unilateral direction to accelerate at the accelerated party’s cost), or even cooperate to facilitate early completion. This is reasonable because time is such a big component of pricing on construction projects. Time is money! Speeding things up requires extra resources. Hence it costs more than budgeted and erodes margins.

When is time set “at large”?

Where the contractor has failed to complete the works by the date for practical completion due to acts or omissions of the principal, the “prevention principle” operates to set time at large. This means that the specific promise to complete by the stipulated date is replaced by an implied obligation to complete within a reasonable time. 

The liquidated damages clause depends on a firm, agreed completion date. This means that when time is set at large due to an act of the principal, the principal’s right to liquidated damages will be lost, unless:

  • the contractor has agreed to complete by the due date notwithstanding the principal’s act or omission; or
  • there is a contractual mechanism to extend the date for practical completion in respect of the delay event (i.e., the EOT regime).

This applies even if the contractor’s progress is such that they would have finished late even in the absence of the Principal’s act or omission.

Where time has been set at large, the principal’s only right is to common law damages arising from the contractor’s breach, being its failure to complete within a reasonable time.

I suspect that time has been set at large on many projects in the current climate, where subcontractors don’t even set foot on site until well after the original date for PC has passed. Even in the absence of compliance with notice and EOT provisions, it is difficult to see a court enforcing LDs in that situation.

What is a contractor or subcontractor to do?

There are a few things subcontractors can do to manage their risk, provided they have read the relevant clauses of the contract at tender stage and taken action before executing the contract. Here are 5 red flags to watch out for in the “program” or “time” clauses of your construction contract:

  1. Negotiate the LDs rate downwards, and agree on a maximum amount of LDs. As a rule of thumb, 10% of the contract sum is a fairly common cap on LDS in commercial construction agreements.
  2. Carefully check the extension of time (EOT) regime and make a note of deadlines. Developing a flowchart can be really helpful for the project management team to understand who must do what and by when.
  3. Make sure the time frames are achievable – negotiate a reasonable period for submitting notices of delay and claims, and make sure the obligation to give notice is triggered by your awareness of the cause of the delay.
  4. Check that the causes of delay that justify an EOT (often called the “qualifying causes of delay” or “excusable causes” include acts and omissions of the principal, its agents, representatives and its other consultants and contractors. This should include variations. While you’re at it, consider which of these qualifying causes should also attract delay costs or damages.
  5. Make sure there are appropriate suspension and termination clauses in the contract (e.g., force majeure).

You don’t have to go it alone

This might seem like a lot, but you don’t need to go it alone. We are here to help you understand the contract and what it means for your project. We can suggest reasonable amendments to reduce the risks. Get in touch for a free 15 minute discovery call to discuss how we can help.

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Get in touch for a free 15 minute discovery call to discuss how we can help.

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About Gemma

I help construction, engineering and consulting businesses create and negotiate clear contracts so they can achieve great project outcomes. I founded SoundLegal to help SMEs in the engineering, construction, consulting and light industrial sectors manage their risk to support business growth, by finding practical, common sense solutions to contractual and other legal challenges. Subscribe to the SoundLegal newsletter “No Jargon” to hear monthly business insights from me.


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