Builders and Contractors Exchange
Weekly Bulletin: 7 nov 2006
Liquidated damages - legal carrot or unenforceable club?
By: Neil S. Lowenstein
Liquidated damage provisions are common in construction contracts, but what are they and is that good or bad? Most contractors consider liquidated damages as a “penalty” for late performance. But they are not and, legally speaking, if they were, they would be unenforceable under Virginia law.
It is often difficult to determine actual damages if construction goes late. For example, what use will be made of the constructed facility; how often; at what profit; at what cost; and etc.? Under Virginia law, damages that are either too remote or too speculative cannot be recovered. So what is the alternative?
Virginia courts permit the parties to predetermine their own estimate of the damages that will result if a breach occurs during performance. Most commonly with construction this is done for construction delays. And, so long as this estimate is a reasonable, fair estimate of the anticipated harm, it is enforceable as the parties’ pre-established determination of damages.
But how often do the parties actually negotiate liquidated damages in construction contracts? Sometimes this is done on commercial projects, but most solicitation documents include a pre-established liquidated damage amount that is incorporated into the contract upon award. Is this a penalty or is it an enforceable liquidation of damages?
The answer varies. Virginia courts are generally reluctant to question agreed contract terms. In fact, a few years ago the Virginia Supreme Court held that one can even pre-agree to waive any challenge to a liquidated damages clause. But if you have not waived your challenge it may be possible to show the liquidated damage clause is an unenforceable penalty if there was no reasoned basis for its calculation.
But why do that? Again, it depends. As noted above, remote or speculative damages cannot be recovered. There are times when liquidated damages clauses are included but there are not any actual damages, even though the construction was delayed. If that were the case, avoiding the assessment of liquidated damages would be financially beneficial. However, beware the brier patch, as – conversely – there are also instances when the liquidated damages undervalue the actual damages, and therefore are a better result.
Bottom line: Liquidated damages that are penalties are not enforceable, but otherwise liquidated damages are generally enforceable in Virginia. Attempted challenge to their imposition varies with the facts and the specific contract terms so, like with all contract provisions, carefully consider their import before finalizing your contract.
Questions?
If you have any questions about this article or any other related matters, please contact:
Neil S. Lowenstein
This article is meant to bring awareness to this topic and is not intended to be used as legal advice.