17. Liquidated Damages, Force Majeure, and Time Extensions
Key Words and Concepts
- Liquidated damages provisions
- Conceptual basis of liquidated damages
- Liquidated damages provisions are a contract remedy
- Judicial attitude to liquidated damages provisions
- Bonus/penalty clauses
- Force majeure
- Common conditions of force majeure
- Contract relief for force majeure
- Time extensions
- Importance of notice of claim
- Contractor responsibility to prove entitlement
- Owner’s responsibility to act
- No time extension until owner grants it
Suppose that you had hired a contractor to build a home for your family that was to be completed and ready for occupancy by a certain agreed date. Based on this expectation, you sold your previous home and were required to vacate by the agreed date that the new home was to be ready. If the contractor failed to complete the new home by that date, you would not only be greatly inconvenienced but might have to rent temporary accommodations until the new home was ready at totally unexpected additional expense. If an ongoing business property or product manufacturing facility had been involved instead, the inconvenience and monetary loss would be increased enormously.
When something like this occurs, who pays, and how much do they pay? If the delay was not the contractor’s fault, what then? How is this situation handled contractually? These and related questions are answered in this chapter.
Today, most large construction contracts contain liquidated damages provisions stating explicitly that, for each calendar day the contract work remains uncompleted after the final completion date stated in the contract, the contractor shall pay the owner a certain dollar amount stated in the contract. Sometimes a series of dollar amounts are stated, each applying if interim completion dates for separate parts of the contract work called milestone completion dates are not met, in addition to the provision applying to the final completion date. These specified payments are intended as reimbursement for the monetary loss suffered by the owner that was caused by the delay in completion. They are called liquidated damages because they are stated as fixed dollar amounts per day.
Conceptual Basis of Liquidated Damages
The conceptual basis of liquidated damages provisions is that, in many cases, the actual damages that the owner will suffer in the event of late completion are very difficult (if not impossible) to determine when the contract was signed. The owner and the contractor, therefore, agree on a fixed daily dollar amount or, if milestone completion dates are specified, fixed daily dollar amounts that are considered a reasonable measure of the extent to which the owner could be damaged by late completion. In practice, the contractor usually has no input into the determination of the daily dollar amount(s). In the public sector and in much private work, the determination is unilaterally made by the owner, and the contract documents are advertised for bids on a “take-it-or-leave-it” basis.
Liquidated Damages Provisions Are a Contract Remedy
Under common law contract principles, a breach of the contract by one party that damages the other entitles the nonbreaching party to the actual monetary damages suffered. Unexcused failure of the contractor to meet the contractually specified completion date clearly is a breach of contract. In the absence of liquidated damages provisions in the contract, the owner would have to itemize the actual damages and present them to the contractor in order to be made whole. If the contractor failed to pay, the owner’s recourse would be to either withhold the amount from money otherwise payable to the contractor or sue, prove the extent of the actual damages, and obtain a judgment compelling the contractor to pay. The liquidated damages provisions relieve the owner from this burden. Their effect is to substitute a contract remedy for a common law breach remedy.
Liquidated Damages Are Not a Penalty
It is important that both parties to the contract realize that liquidated damages are a contractually specified remedy to make the owner whole in the event of late completion. They cannot be properly assessed as a penalty to punish the contractor for some act that displeases the owner or, when not properly due, as pressure to coerce the contractor into a course of action favorable to the owner. In cases of disputed liquidated damages assessments, the courts will not support punitive or coercive motives on the part of the owner.
For instance, the Iowa Supreme Court ruled in 1991 that liquidated damages clauses in three highway contracts were unenforceable penalties. The contractor had entered into three simultaneous contracts for highway resurfacing that each required completion within 40 days and called for liquidated damages of $400 per day. The contractor finished two of the contracts behind schedule. A county department had withheld a total of $32,400 in liquidated damages. The contractor filed suit to recover the withheld money, alleging that the imposition of liquidated damages was punitive in nature. The court held that a project owner must be able to show how the daily rate was determined in order to enforce a liquidated damages clause. In this case, the county disregarded their own construction manual, which called for a sliding daily rate based on the total contract price. The three contracts ranged from a contract price of $37,957 to $251,696, yet the county assessed a daily rate of $400 in each case. Further, at the trial, one of the county’s engineers testified, “We wanted the liquidated damages amount to be sufficient to make the contractor aware that we need that project completed.” In the court’s view, this testimony added to the impression that the liquidated damages assessment was intended as a penalty rather than reflecting the level of damages that conceivably could have been suffered from late completion. In ruling for the contractor, the Iowa Supreme Court said:
No witness was called to justify the suggested liquidated damages amount contained in the DOT manual schedule. The county engineer did not conduct studies or present any other data suggesting that the defendants anticipated that the government entities and the public could sustain damages equivalent to the $400 per day liquidated damages amount contained in each of the three contracts. … Therefore, we conclude that the $400 per day liquidated damages clause is an unreasonable amount and therefore a penalty that should not be enforced.
Judicial Attitude Toward liquidated Damages Provisions
The contractor in the previously related case was fortunate. The current judicial attitude toward liquidated damages is to enforce such provisions in the event of unexcused late completion. The owner does not have to prove the amount of damages or that any damages resulted as a consequence of late completion. For every unexcused day of late completion, the owner is generally due the liquidated amount stated in the contract. However, there are exceptions. In addition to overturning improper assessments made for punitive or coercive purposes, courts may overturn liquidated damages assessments if the daily amount stated in the contract does not bear a reasonable relationship to the amount that the owner could be thought to be damaged. The standard of reasonableness is based on whether the daily amount is a reasonable estimate of the extent to which the owner might be damaged by late completion, in light of the level of knowledge possessed by the owner and contractor when the contract was signed.
A typical judicial holding along these lines is exemplified by a 1985 decision of the Corps of Engineers Board of Contract Appeals. A contract for the construction of rest area facilities allowed 90 days for performance and called for liquidated damages of $143 per day for late completion. The contractor was very late in completing the work, and the government assessed liquidated damages of $18,447 against a total contract amount of $29,189. In supporting the contractor’s appeal of this relatively large liquidated damages assessment, the Board of Contract Appeals said:
The Board concludes that the liquidated damages provision in this contract was not based on any reasonable forecast of probable damages that might follow a breach, and therefore that the liquidated damages provision will not be enforced.
Even though payment is sometimes evaded as just explained, contractors are well advised in planning the performance of their contract work to believe that liquidated damages provisions will be enforced.
Can the liquidated damages provisions be applied in reverse if the contractor finishes early? If the owner is damaged for every day’s late completion, is there a like benefit from every day’s early completion? Not necessarily. The owner may not have planned on the use of the completed facility until the specified contract completion date and may be unprepared to occupy and use it in the event of early delivery. There are other reasons as well why early completion might not benefit the owner. Therefore, the typical liquidated damages clause cannot be applied in reverse for early completion. However, contracts sometimes contain a bonus/penalty clause that does provide the contractor a monetary benefit for early completion as well as providing for payment to the owner in the event of late completion. Usually, the daily rate for early completion will be less than the rate for late completion. Bonus/penalty clauses are relatively rare in the public sector although quite common in private work.
In a contractual sense, force majeure means a condition beyond a party’s control. An owner-caused delay would be a condition of force majeure from the standpoint of the contractor, even though the delay was within the control of the owner. On the other hand, inclement weather or a flood are conditions of force majeure from the standpoint of both parties.
Common Conditions of Force Majeure
In addition to owner-caused delays, acts of God, war, riots, labor strikes, inability to obtain critical materials when all proper procurement actions have been taken, and other similar situations are common conditions of force majeure. It should be noted that mere failure of a prime contractor’s subcontractors or material suppliers to perform in a manner that meets the time requirements of the prime contract seldom constitutes a condition of force majeure, since both are under the control of the prime contractor. For a subcontractor or material supplier delay to be considered force majeure, it is necessary for the prime contractor to prove that the inability of the subcontractor or material supplier to perform is caused by conditions not only beyond their control but beyond the control of the prime contractor as well. This is usually a heavy burden of proof.
Contract Relief for Conditions of Force Majeure
Since such conditions are not the contractor’s fault, the contract relief for conditions of force majeure normally is an extension of contract time to avoid the unfair assessment of liquidated damages. The resulting delay is contractually considered excusable. If the contract does not contain an enforceable no-damages-for-delay clause and the condition was caused by the owner, the delay is also compensable, entitling the contractor to both a time extension and additional payment.
Even though extensions of contract time for conditions of force majeure are promised by the contract, they are far from automatic. The contractor must follow prescribed contract procedures and must prove entitlement to assure that contractually justified time extensions will be forthcoming.
Importance of Notice of Claim
Most contracts contain a provision that the contractor claiming entitlement to a time extension must file notice of claim within a stated number of calendar days after the event giving rise to the claim or waive the right to relief. Although sometimes the owner has constructive notice of the cause of the delay for which the contractor is entitled to a time extension, the importance of the contractor filing time extension claims within the contractually prescribed time cannot be overemphasized.
The owner has no duty to grant a time extension if the contractor has not requested one. Therefore, when the contractor has been delayed, an immediate request for a time extension should be submitted in writing. The initial notice should be followed by a written claim for the number of days that the completion of the contract has been delayed. The claim should be filed at the earliest possible time following the end of the delay so that the total extent of the delay can be determined. This is normally shortly after the conclusion of the delay.
The importance of notice is dramatically illustrated in the following 1991 decision of the Alabama Supreme Court who reversed a trial court decision in favor of a contractor who had been assessed $85,500 in liquidated damages on a contract for site preparation and road construction for a residential subdivision. The contract called for liquidated damages of $300 per day for late completion and provided that time extensions for delay beyond the control and without the fault of the contractor would be granted, provided that written requests for time extensions were submitted to the owner’s engineer within 20 days of commencement of the delay. The contract also contained a no-damages-for-delay clause, so the only remedy for delay was an extension of time. The contractor completed the contract 285 days behind schedule but contested the liquidated damages assessment on the grounds that the delay had been caused by the interference of the owner’s separate utility contractor and therefore was excusable. A trial court agreed and remitted the liquidated damages to the contractor.
On appeal, the Supreme Court of Alabama reversed, stating that the contractor was aware of the requirement to submit a written request within 20 days of the event giving rise to a request for an extension of time and had, in fact, complied with that procedure on one occasion when receiving a 45-day extension of time for a separate cause. Holding that the contractor had waived any right to extensions of time, the Supreme Court stated:
The Cove Creek contract provided that time was of the essence and then went on to specify liquidated damages for delay. The contract also contained a provision for extensions, and APAC availed itself of that provision on at least one occasion and received a 45 day extension because of delays caused by R & M. We hold that APAC’s delays were not excusable and that it is bound by the contract and subject to the liquidated damages provisions.
Contractor Responsibility to Prove Entitlement
In any type of claim situation, whether for time, additional contract payment, or both, the contractor-claimant bears the legal burden to prove entitlement under the terms of the contract to whatever is being claimed. For this reason, the contractor must support a time extension claim by showing that delaying events beyond his or her control have consumed part of the time allotted by the contract for performance of the contract work-in other words, by showing that the delaying events have extended contract completion. This is usually done by supporting the claim with a critical path method (CPM) schedule analysis indicating the extent of the overall delay to the project.
Owner’s Responsibility and Contractor Tame-Extension Requests
Contractors bear the heavy contractual burden of performing the required contract work within the contract time period. They also are contractually entitled to the benefit of having the contract time extended due to the impact of an excusable or compensable delay within a reasonable time after the delay ends so that they can properly and efficiently plan the remaining contract work. To secure this right, it is incumbent upon the contractor at the conclusion of each significant delay to make a CPM schedule analysis and to request a discrete number of days’ time extension in accordance with the result of the analysis, which should also be submitted to the owner in support of the contractor’s claim. The majority of courts today support this approach, as well as holding that if an owner receives a time extension claim properly supported in this manner, the owner has a duty to grant the time extension in a timely manner rather than waiting until the end-of-project performance before granting it. Failure of the owner to grant a properly supported request for an extension of contract time or failure to grant it in a timely manner is a breach of the contract.
Granting of Time Extensions
The contractor may not safely assume that a time extension will be granted simply because it has been properly claimed and the contractor believes it to be due. A time extension can only be granted by a formal change to the contract executed by the owner. Regardless of the merits of the contractor’s claim, the contract date is not extended until and unless the owner has formally notified the contractor by a written change to the contract that the contract has been extended by a stated number of calendar days to the new date stated. An oral intimation that the contract will be extended or may be extended if the contractor “needs it later” to avoid being assessed liquidated damages is not sufficient or contractually proper. Once the owner has had sufficient time to act following receipt of the contractor’s claim for a time extension and a change to the contract has not been initiated, the contractor must necessarily assume that the claim has been denied.
If the owner fails to act on a properly supported contractor time extension claim or denies it directly, the contractor’s proper course of action is clear. First, a notice should be filed in writing protesting the denial or lack of timely action as the case may be, and, second, the contractor should take all possible and reasonable action to meet the unextended contract completion date. By failing to prosecute the work in a manner that assures project completion by the then-existing completion date, the contractor is exposed to a breach of contract determination by the owner that could result in the contract being terminated for default. Although a court may eventually declare the default termination to be improper, the long legal battle that would ensue is an expensive burden. The contractor’s proper contractual position after protesting in writing is to attempt to meet the unextended contract completion date and pursue a separate remedy under the doctrine of constructive acceleration, which is discussed in Chapter 19.
This chapter discussed the general concepts of liquidated damages, force majeure, and contract time extensions. Contractor time extension claims, owner entitlement to liquidated damages, and contractor claims for monetary damages for compensable delays are closely related issues and must normally be determined by a structured CPM schedule analysis. The following chapter explains how the owner’s and contractor’s respective liabilities and entitlements are sorted out in practice by this method.
Questions and Problems
- Is an owner’s right to assess and collect liquidated damages an express or an implied right under a construction contract? Who ordinarily determines the daily amount? What is the general attitude of courts concerning the determination of this amount?
- Can liquidated damages provisions be properly used as a means of intimidation or coercion? Can they be properly assessed as a penalty?
- Under typical contract provisions, can liquidated damages be applied in reverse for early completion? What are the provisions of a bonus/penalty clause?
- What is a condition of force majeure? From the contractor’s standpoint, can such a condition be caused by the owner? Why is the mere failure of a material supplier or a subcontractor to perform often not a condition of force majeure? What relief does a contractor usually receive for costs incurred because of delays caused by an act of God? Same question when the delay is caused by an act of the owner?
- When a delay has occurred because of an act of God or some other cause beyond the contractor’s control, does the owner have the duty automatically to grant an extension of time? If not, what triggers the owner’s duty to act?
- When an owner does grant an extension of time, how is this act accomplished contractually?
- What are two separate aspects of an owner’s duty when the contractor presents a properly supported and justified claim for an extension of time during contract performance? Is the owner’s duty met by granting the extension of time after the contract work is completed if the contractor “needs” the extension of time to avoid the assessment of liquidated damages? Why is timeliness in the owner’s granting a time extension an important factor from the contractor’s standpoint?
- What is the contractor’s proper course of action when justified extensions of time have been properly claimed and the owner refuses to grant them and/or simply fails to act on them? Why? What is the contractor’s proper contractual position in this situation?