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Court Finds Liquidated Damages Clause Unenforceable

I recently gave a presentation on essential construction contract provisions at the annual conference for the Florida Municipal Attorneys Association. Part of my presentation addressed liquidated damages clauses in government construction contract. After speaking, I was approached with follow-up questions about how to determine the proper daily rate for liquidated damages in construction contracts.

A liquidated damages clause is an owner-preferred contract provision that usually sets a fixed amount for which the contractor is liable to the owner if the project is not finished on time. Often, the amount is set as a certain sum of money per day the project is late (e.g., $1,000 per day).

Generally, liquidated damages provisions are enforceable. But there are circumstances where courts will refuse to enforce such a provision (click here for a recent Florida case where the court found a liquidated damages provision unenforceable).

Under Florida law, a liquidated damages clause will not be enforced if a court concludes it is a penalty clause. There is a two-part test for determining whether a liquidated damages clause will be stricken:

(1) the damages flowing from a breach of contract are not readily ascertainable; and

(2) the daily rate of liquidated damages is not grossly disproportionate to the damages that might be expected to flow from a breach.

There does not appear to be a bright-line rule for determining the proper daily amount of liquidated damages to assess against a contractor for untimely completion of a project.

One way for a project owner to increase the chances that a liquidated damages clause will be enforced is to make a pre-estimate of probable actual damages that will flow from the contractor’s late completion of a project.

If an owner performs a pre-estimate, that may show that the daily liquidated damages rate was not pulled out of thin air. If a pre-estimate is not performed, that may give the contractor an argument that the liquidated damages provision is nothing more than an unenforceable penalty.

The enforceability of a liquidated damages clause was considered in D.A. Nolt, Inc. v. Philadelphia Municipal Authority (link to case here). In that case, a contractor sued a public owner for $2.6 million in damages arising from a police headquarters renovation project.

The owner filed a counterclaim against the contractor and alleged the contractor completed the project 255 days late. As a result, the City alleged it incurred $2.7 million in actual damages or, alternatively, $2.55 million in liquidated damages based the contract’s $10,000 per day liquidated damages clause.

The contractor filed a summary-judgment motion requesting the court to dismiss the owner’s liquidated damages claim. The contractor argued that the liquidated damages provision was an unenforceable penalty because it was not based on the owner’s possible harm if the project was not timely completed.

The court considered whether the actions the owner took to determine the liquidated damages provision rendered the $10,000 daily rate unenforceable. As a part of that analysis, the court considered the following two facts:

(1) The person who performed the pre-estimate analysis to determine the liquidated-damages rate relied on past analyses the owner performed on other projects, but that person had no first-hand knowledge of the nature of those analyses.

(2) The analyses relied on from other projects were for projects that had costs that were not at issue in the project that was the subject of the lawsuit (e.g., one prior liquidated damages analysis relied upon was for a correctional facility that included the cost of rent for a temporary facility to house inmates during a delay).

Based on these findings and the fact that the pertinent project was, arguably, smaller that the other projects the owner relied upon, the court doubted that it would be appropriate to allow the owner to use the liquidated damages provision from those other, earlier projects.

The court then found that the owner’s liquidated damages provision was not based on a reasonable forecast of probable costs associated with a delay. Thus, the court concluded that the $10,000 per day liquidated damages clause was unenforceable as a matter of law and dismissed the owner’s liquidated damages claim.

Bottom Line: Liquidated damages clauses are frequently the subject of litigation in construction disputes. The owner will always be tempted to have the highest daily rate possible, but the owner should be careful to not arbitrarily select a daily rate. Instead, the owner should do its best to make at least some attempt to quantify the actual damages it will suffer should the contractor not timely complete the project.

If you have any questions about the enforceability of a liquidated damages clause, please feel free to reach out.

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