Chris Cazenave | Jones Walker
Liquidated damage clauses are omnipresent in today’s construction contracts—often considered in early negotiations to provide a degree of certainty and limit financial liability.
There are two principal types of LDs appearing in construction contracts—(i.) damages for delay when a contractor fails to deliver a project by a certain milestone; and (ii.) performance damages when a contractor fails to meet specific performance requirements. Differentiating between LDs for delay and LDs for performance—especially when both LD types are combined in the same contract—is key to risk awareness and allocation during contract negotiations and throughout performance.
This article briefly outlines what you should know about LDs for delay and LDs for failing to meet certain performance requirements. The article also covers how contractors can allocate and cap risks based on risks each party can either manage, insure, or otherwise limit.
Liquidated Damages for Delay and Performance
Delay LDs are intended to compensate the owner for loss and damage caused as a result of late completion. Delay LDs are typically expressed as a daily rate that the contractor must pay the owner for each day the contractor fails to meet a certain milestone—for example, the date of substantial completion. The daily rate is intended to represent the pre-estimated loss and damage that the owner will suffer as a result of each day the contractor fails to achieve contractually defined milestones, which may be a single milestone such as substantial completion or can be any number of milestones such as percent-complete or turnover of as-built project documentation.
Different than delay LDs, the purpose of performance LDs is to compensate the owner for loss and damages suffered over the life of the project if the facility fails to achieve a specified output. Take for example, an offshore wind turbine with a project cost of $10,000,000 that annually produces only 3 million kWh instead of 6 million kWh as specified, or only 50% of nameplate capacity. The measure of performance LDs—presumably up to a maximum liability cap discussed below—could be the net present value of revenue lost by the owner over the projected life of the turbine by being unable to sell the extra 3 million kWh per year as contemplated by the construction contract. The performance guarantee is supported by performance LDs payable by the contractor if it fails to meet the guarantees.
Liability Caps for LDs
The purpose of LDs is to limit liability—not to bet the company. A liability cap can apply to any liabilities that may arise under the contract or it can be limited to certain kinds of liability, such as liability for delay (delay LDs) or liability for failure to meet a performance guarantee (performance LDs).
Consider LDs and liability caps in a budding construction market such as offshore wind, and the example above where a contractor delivered an offshore wind turbine with a project cost of $10,000,000 that annually produces only 3 million kWh instead of 6 million kWh as specified, or only 50% of annual nameplate capacity. In this example, assume performance LDs are $1 per kWh produced less than annual nameplate capacity (6 million (kWh) – 3 million (kWh) = 3 million (kWh) * $1 = $3,000,000/year in performance LDs). Also assume delay LDs of $50,000 per day for each day substantial completion extends past the contractual date for substantial completion. With no liability caps and even with other limiting provisions such as a waiver of consequential damages, the contractor in this example faces unlimited downside risk that could take the form of either or both performance LDs and delay LDs. Failure by this contractor to deliver a wind turbine on time at 100% operating capacity could leave the contractor betting her company where LDs far exceed the $10,000,000 value of the contract.
Total liability caps can be used to allocate and limit risk for the party in the best position to control or manage that risk. As to delay, the contractor here could negotiate a lower daily LD rate and/or cap the total amount of liquidated damages that can be assessed for failing to substantially complete before the contractual substantial completion date. Similarly, the contractor could help reduce liability for the turbine’s performance by capping performance LDs as a percentage of the total contract price or a fixed dollar amount. A simpler and more streamlined option to also consider is a blanket liability cap limiting the contractor’s aggregate liability on the entire project—whether for performance, delay, workmanship, or any combination of issues that may give rise to contractor liability.
Key Takeaways
- Liquidated damages for delay and performance—in combination with liability caps and other limiting provisions such as a waiver of consequential damages—are critical tools for contractors to negotiate reasonable limitations of liability.
- Understand the key differences between delay LDs and performance LDs including awareness that delay LDs and performance LDs can be cumulative and non-exclusive of other types of damages (such as the cost to repair defective work). Consider a cap on the contractor’s aggregate liability on the entire project as one potential way to avoid uncertainty of potentially snowballing damage remedies for the owner.
- Attempt to allocate and cap risks based on risks each party can either manage, insure, or otherwise limit.
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