ConstructionPro Week, Volume: 4 - Issue: 12 - 03/27/2015

Are Liquidated Damages Based on Phantom Owner Costs?

By Bruce Jervis

Liquidated damages are assessed against contractors for late completion of a project. They are intended to compensate project owners for the costs of an extended construction period and the delayed use of the facility. Liquidated damages clauses are generally enforceable if the daily rate represents a reasonable forecast, at the time of contract formation, of the owner’s actual costs. If the daily rate is arbitrary – merely an incentive for timely completion by the contractor – the clause may be ruled an unenforceable penalty.

On public works projects, the determination of the daily rate of liquidated damages is controversial. Public project owners do not have construction loans. Completed public projects do not generate revenue. What are the owner’s costs of late completion? They are primarily extended inspection and administration costs.

A contractor on a recent federal project challenged a daily rate on the grounds the government’s inspection and administration costs were phantom. Government personnel costs are fixed; federal employees do not work more hours or get paid more salary as a result of delayed project completion. This argument was rejected. Although personnel costs may be fixed, allocation of efforts to a delayed project detracts from the attention provided to other projects. The resulting inefficiency is a real cost to the government.

What do you think? Are liquidated damages on public works projects justified by real costs to project owners? Or, is the daily rate of liquidated damages really just a threat used as leverage to motivate timely project completion?

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COMMENTS

Public owners do have additional costs for late completion of public projects. For instance: additional lease costs for temporary space the owner's moved offices or other uses into, and the loss of revenue from campgrounds or other spaces for which user fees are charged are two which come to mind.
Posted by: Irene Henry - Friday, March 27, 2015 1:34 PM

If you are a public entity that is required to provide facilities on a scheduled basis, such as a school,the cost incurred from not being able to perform statutory activities may be incalculable. The harm to the educational program, the families and the school staff extends way beyond a simple calculation of rental costs or loss of revenue.
Posted by: Phillip Zemke - Friday, March 27, 2015 2:03 PM

I agree with the two earlier postings; public owners do have real costs for late completion. The additional engineering costs are the most obvious and perhaps the easiest to estimate but there are a lot of other examples. If the project includes an automated chemical feed facility, the labor costs of adding chemicals on a daily basis is a real cost that will be eliminated when the project is completed. On many wastewater facilities, an owner may be under a consent order and face fines if the facility is not in service by a given date. Who should bear those costs other than the contractor? Where we are able to estimate the damages and put documentation on the files as to how the LDs were calculated we do, but some costs are only potential such as fines. For those we often have a separate "Special Damages" clause in addition to an LD clause. The Special Damages are written to advise the Contractor that there may be additional real costs in addition to the LDs and that they will only be assessed if the owner has to pay them.
Posted by: Jim Brown - Friday, March 27, 2015 4:53 PM

Owner operation cost (inspection, safety, security etc.) is the main driver of LD. Loss of revenue is another driver. It's an art of delicate balance setting LD. If it is too high, no one will bid. If it is low bidder will underestimate the seriousness of the milestone's deadline.
Posted by: Mohammed - Friday, March 27, 2015 6:13 PM

These posts seem to indicate that whether liquidated damages on a public project (and the AMOUNT of the liquidated damages) should be considered on a case-by-case basis. In some cases, they are in fact "phantom" and should not be assessed, while in other cases they cover "real" costs and should be enforced.
Posted by: Rob Pitkin - Sunday, March 29, 2015 8:38 AM