Constructive Notes ®
A common issue when finalising contracts is how to determine the rate for liquidated damages. We have set out below a general summary of the principles. This is a guide only and every contract will be different.
In general terms:
- Liquidated damages are amounts agreed between the parties to be payable by the Contractor if the Contractor breaches the contract by failing to reach project completion by the date required by the contract (subject to extensions of time applied);
- Liquidated damages give certainty to all parties (including financiers);
- Liquidated damages must reflect the amount of the loss which the Principal would expect to suffer if the Contractor delays completion of the Project (or of separate stages or portions of the Project);
- The amount is usually specified for each day by which the Project is delayed (it can be specified weekly or other time frames, but a daily measure generally is easier to ascertain as it aligns with the manner in which delays and extensions of time are generally measured);
- The law in Australia has historically required that the agreed daily amount not be “extravagant or unconscionable” compared to the greatest loss that could conceivably be proved to have naturally flowed from the delay;
- Parties should ensure that the agreed daily amount is a “genuine pre-estimate of the loss” which the Principal would suffer if Project completion is delayed;
- The agreed amount must be truly compensatory, and not a disproportionate penalty; and
- Ultimately, a liquidated damages provision will be an invalid penalty and unenforceable, if the daily amount is out of all proportion to the Principal’s legitimate interests in securing completion of the works by the agreed contractual date.
Broadly, in arriving at an amount for liquidated damages, you need to:
- Consider the position the Principal would be in if the Project is not delayed;
- Consider the position the Principal would be in if the Project is delayed; and
- Assess the amount which would be required to be paid to the Principal to put it (so far as money could) in the same position the Principal would have been in if the Project was not delayed.
The Principal may like to assess those costs for potential delays of various periods, and then compare and reduce them back to a daily rate from there.
Liquidated damages can be staggered. For example, It may be that the first 4 weeks of delay involve low cost but from 4 weeks on the cost is much higher due to the commercial considerations of the type listed below. In that case the parties are at liberty to agree a daily rate for the first 4 weeks and a different daily rate after 4 weeks.
Possible factors that the Principal could take into account would include:
- Any additional fees payable to the contract Superintendent;
- Any additional fees payable to other consultants and advisers;
- Any additional costs associated with site offices or temporary arrangements for the extended period;
- Any additional costs payable for extended access to the site through adjoining land, for the extended period (in this regard access deeds with neighbours and arrangements with local authorities may be relevant);
- Any loss of income from tenants or residents, or any delay in receiving anticipated income from tenants or residents (agreements for lease and similar and existing lease or rental agreements are relevant here);
- Any loss from cancelled sales – this is a difficult point and should be carefully considered (if a deposit must be paid back but a new sale agreement is signed with a different buyer then the deposit itself is not a loss as it is recovered in the new sale; however, the offset on finance costs by losing deposits could be a consideration);
- Any loss of income from Government (or other sources), or any delay in receiving anticipated income from Government (or other sources), including government grants that are time critical;
- Any loss of anticipated profits from other / future projects, although it may be necessary to distinguish between profits which are actually lost from those which are merely deferred;
- Any additional staff or supplier costs, for the extended period (again this can pose difficulties – where there are permanent staff being paid irrespective of the Project or delay, those are likely to be costs that the Principal incurs regardless; conversely, costs of temporary project specific staff or contracted staff or new staff put on to deal specifically with the delay, the additional costs would likely be attributable to the delay);
- Any additional cleaning or security costs, for the extended period;
- Any additional costs of confirming continuing compliance with statutory obligations, for the extended period;
- Any additional insurance costs associated with a longer Project period;
- Any additional costs associated with seeking necessary extensions to the scheduled Project completion date that relate to grants or government funding;
- If quantifiable, any potential loss of opportunity for the Principal;
- Loss of income claims from existing commercial tenants (this is particularly the case where there are access restrictions on customers such as in shopping centres or malls);
- If relevant, any ongoing finance costs or additional financing;
- Other commercial costs (for example where the Principal or a prospective tenant is required to extend an existing lease or take an interim lease instead of moving into the building being constructed); and
- Any costs associated with any bonds (such as where a bond is payable to Transport and Main Roads or local authorities for road use or closure or payable to utilities providers) which is required to be on call for longer than expected.
There may be other factors which are Project specific or that the Principal would identify from its knowledge of potential use or prior operations at the site.
The Principal should retain the calculations and estimates which form the basis for proposed liquidated damages amounts, for discussion with the Contractor if necessary, or for substantiating them in the future if it were ever to become an issue. Any assumptions on which the calculations and estimates are made should also be noted and retained.
The amount of liquidated damages does not need to be perfect but it must not be “extravagant or unconscionable” (hence a “genuine pre-estimate of the loss” and why records should be kept to show how it was ascertained).
The Principal should avoid the temptation to simply agree a daily percentage of the contract sum for convenience as this may not be a genuine pre-estimate and if too high may be a penalty.
Most contractors will require a cap on liquidated damages. The cap if agreed should not be so small as to make liquidated damages no disincentive to delay. Generally, most contractors will request a cap at 5-10% of the contract sum as this represents loss of the profit margin. In practical terms, no contractor wishes to continue working on a project where they make no profit (and start to lose money due to increased costs of being on site longer) so a cap at this level is usually a strong disincentive to delay.
If, rather than liquidated damages, you wish to be able to claim general delay damages (which unlike liquidated damages cannot simply be applied but, unless agreed by the parties, must ultimately be proven up and determined by a court or tribunal of relevant jurisdiction) then this should be very clear. We advise against listing liquidated damages as nil, zero or not applicable as each has issues of uncertainty. Rather, for certainty, the wording should be clear, for example “liquidated damages do not apply, the Principal reserves rights to claim general damages for delay.”
We have not delved in detail into the case law surrounding liquidated damages as this area of law has a long and varied history. If there are concerns about any aspect of the nature of or calculation of liquidated damages legal advice should be sought.
This article may provide CPD/CLE/CIP points through your relevant industry organisation.
The material contained in this publication is in the nature of general comment only, and neither purports nor is intended to be advice on any particular matter. No reader should act on the basis of any matter contained in this publication without considering, and if necessary, taking appropriate professional advice upon their own particular circumstances.
