Qualifying Factors, Unforeseeable Penalties, Mutual Delays

Misconceptions & Guidelines

[The following text is transcribed from the Construction Contracts & Liquated Damages Provisions webinar]

So what we thought we would do is go through some of the misconceptions that are commonly imposed, or we commonly hear within the industry. And, you know, obviously, it starts with first and foremost that an owner cannot insert and enforce a liquidated damages clause without an attorney bonus provision. And as Steven Nudelman well noted, you don’t need to have one in order to have the other. That would be a misconception that you don’t have to have a bonus provision in order to assess liquidated damages. Similarly, liquidated damages will be enforced if the provision states it is not a penalty. Just simply stating that it’s not a penalty doesn’t mean that it is not a penalty. And some of the examples that Stephen had provided in the event that a contract or an owner insists that it’s going to be a million dollars a day for each day that the movie theater is not open – how reasonable are those damages? Even if, in the contract, they stipulate that it is not a penalty, in reality, it very well will be a penalty in that regard. Another misconception is that LDS cannot be assessed on a contractor beyond the date on which the contractor abandons the project. And so that can certainly be imposed, specifically in the event that delays leading up to and beyond the abandonment of the project, or termination would lend itself to be the responsibility of the contractor that either abandoned or was rightfully terminated. So all these can continue to be assessed beyond that.

Another misconception is that recovery of damages cannot be enforced if the court finds it to be a penalty. There still can be damages that are going to be assessed. We talked about the ability to get actual damages over liquidated damages. And in that event, one would want to calculate, and often I’m in a situation where I’m calculating both actual damages and liquidated damages. In the event that we give a trier of fact the option in the event that it is really a contractual argument on both. So having both and knowing what both are is going to be important as you develop your legal strategy. Another misconception is an owner is entitled to recovery of the higher amount between the actual liquidated damages. Again, it’s an either-or scenario, not a let-me-choose at the end of the day. And so that’s something that one would want to look at. While it does help to calculate the actual damages in the event that you do have liquidated damages in the contract. That’s typically what we would look towards.

Another misconception is liquidated damages cannot be recovered if the owner does not provide evidence that it sustained actual damages. Steven gave a fantastic scenario of the movie there, that at the time in which the contract was executed, the reasonable forecast was you know, a reasonable amount of dollars per day that they could that they had reasonably estimated they would incur as a result of not having that movie theater open. It was done pre-pandemic. So in the event that you’re looking at a pandemic opening or a post-pandemic opening, you’re looking at what are the actual damages that are going to be sustained by the owner. In that regard, it could be nominal or nothing at all in the event that they could open anyway because of the pandemic. So, just because there are no actual damages, does not mean that an owner cannot recover liquidated damages in the event that they have that provision in the contract.

Another misconception is that an owner is entitled to recovery for delays that occur after substantial completion or beneficial occupancy. Steven gave a great example of this potential depletion doctrine, noting that that’s still a possibility after substantial completion. So that is a common misconception that is often referred to. So looking there, several more misconceptions. I’m sure this is just a general listing of some of the things that we’ve covered throughout the course of today’s webinar.

Guidelines For Formation & Types of Liquidated Damages

So then the question then becomes, well, what are some of the guiding principles that one would have in the event that they are formulating the different liquidated damages amounts? And what do they need to consider as a result of going through that calculation? And the key thing here is what are the recoverable damages that one would need to consider and so, as a damages expert I often look at what is the actual damage as a result of the inability for an owner to not be able to incur rent, lost views, not being able to move in, you know how much additional cost, they’re gonna occur not only from that facility but also from the facility that there may be currently housed in what additional permits and licenses and then there could be an extension of those because of the delays? What are some of the right away costs? And then, of course, what are some of the extended or increased financing costs that are going to occur as a result of not achieving substantial completion as originally forecasted? Are there additional loans that have to be done? I’ve often been in a situation where an owner had to go out and get a mezzanine loan to finance the additional time that they’ve lost due to loss of rent.

So oftentimes, owners will go through a developer to perform very early on a job and anticipate and make business decisions based upon those. And so some simple questions. And we typically ask at the stage of drafting the contract, (we’re trying to develop the liquidated damage amount that’s reasonable), what additional cost am I going to incur on the job? And for not having beneficial use of that facility? How much lost revenue and profit? Am I going to lose per day? In this situation, where we’re talking about a hotel, what is the previous performance of that hotel? In a similar size? City? What are the expected occupancy rates for the given type of hotel? And then what was I forecasting out at the time in which I was looking to maybe secure financing for that project? So, and then, of course, what is the additional cost I would incur? Meaning, if I had to extend my loans out? If I had to secure additional financing? What were those costs moving forward? Are there are any ancillary costs for the government that may be imposed? Maybe I have some incentives? That’s a common question that comes up – is a city or municipality providing incentives for an owner to move their facility into a given jurisdiction? And as a result, I may be at a loss in the event that I can have X number of employees and that given space, as anticipated, because of the delays that occurred on the job. Well, I may be out of those incentives as well.

So factoring all those key components into the liquidated damages amount would be a starting point. And then, of course, interest, and then there are other third-party contracts. So there’s a litany of questions that one would ask and I think when we go through and develop the reasonable estimate, we go through these lists of questions, and then what we typically would do is compile all that information and use it as a basis. It may not be reflected in the contract, but at least as an owner, I have that as a basis that I can rely upon in the event that the liquidated damage amount is challenged down the road. So in the event that a delay claim or delayed related dispute does arise, I as an owner have the basis of how I calculated the liquidated damages amount on a daily basis from what I could reasonably anticipate at that given stage.

To view the entire webinar, click here: Construction Contracts and Liquidated Damage Provisions: Qualifying Factors, Unenforceable Penalties, Mutual Delays

Thank you, Strafford, for hosting this event. Click to learn more about Strafford Publications.