Unknown Exposure: Liquidated Damages in Construction Contracts

An oft disputed, and occasionally misunderstood, provision in construction contracts is that of Liquidated Damages (commonly referred to as “LDs”).  Generally speaking, Liquidated Damages refer to a sum of money which a party to a contract agrees to pay to the non-breaching party if they break a promise in the contract.  In a construction setting, this is most commonly seen in the context of delays on a construction project.   Said differently, the parties to the construction contract agree to a certain sum, generally calculated on a daily basis, that a breaching party will pay to the non-breaching party in the event of delay to the project.  In theory, LDs provide a means for the parties to a construction contract to avoid expensive litigation in determining the amount of financial damage suffered by the non-breaching party as a result of the delay caused by the breaching party.  However, LD clauses are often misapplied, misallocated, or miscalculated, resulting in additional disputes and costs to the parties.

The courts of North Carolina are willing to enforce Liquated Damage provisions of construction contracts, so long as the liquidated damages to be assessed are not seen as “penalties” to the breaching party.  This may seem counterintuitive, in that LDs are the sum that a breaching party pays to a non-breaching party, in the event of breach.  However, the actual purpose is not to “punish” a breaching party but rather to establish, up front, the amount needed to reasonably compensate the non-breaching party for losses which it will likely incur as a result of the breach.   In determining the enforceability of a Liquidated Damage provision in North Carolina, the Court will apply the following questions:

1) “Whether the damages which the parties reasonably anticipate are difficult to ascertain because of their indefiniteness or uncertainty” AND

2) “Where the amount stipulated is either a reasonable estimate of the damages which would probably be caused by a breach or is reasonably proportionate to the damages which have actually been caused by the breach”.

Because North Carolina courts are willing to enforce Liquidated Damages provisions (presuming the provision survives the two question test above) the parties to a construction contract should give careful thought when preparing or evaluating a LD provision.  Things to consider should include: the reasonableness of any liquidated damage amount against the total sum of the contract, any uncertainties which could hinder full performance of contractual duties, the ability to ascertain the specific or actual amount of damage which would result from delay, the flexibility of the construction schedule and critical path, change order procedures as they relate to extensions of time, and the ability to accelerate performance of contractual duties.

If you have questions related to construction contracts or liquidated damage provisions, please feel free to contact our office.

– Cody R. Loughridge