Are liquidated damages clauses in construction contracts enforceable? That’s a question that is often litigated in construction disputes.

It’s not surprising that some of the most popular articles on this blog address examples of courts refusing to enforce liquidated damages clauses in a construction contracts. For two examples of Florida courts finding liquidated damages clauses unenforceable, click here and click here.

Generally, liquidated damages provisions are enforceable. But there are circumstances where courts will refuse to enforce such a provision. Under Florida law, a liquidated damages clause will not be enforced if a court concludes it is a penalty clause. There is a two-part test for determining whether a liquidated damages clause will be stricken:

(1) the damages flowing from a breach of contract are not readily ascertainable; and

(2) the daily rate of liquidated damages is not grossly disproportionate to the damages that might be expected to flow from a breach.

While not a Florida case, a Georgia court recently considered whether a liquidated damages clause in a construction contract was enforceable.

In City of Brookhaven v. Multiplex, LLC, a city awarded a $3 million contract to a contractor for the demolition of an old park and the construction of a new park to replace the old one. The contract required the contractor to complete the park by a specific deadline and if the contractor failed to timely complete the park, there was a liquidated damages clause that provided the following:

[Contractor] shall have 180 days from the notice to proceed to complete the project. Failure to complete the required construction as specified will result in the assessment of Liquidated Damages at the rate of $1,000 per calendar day.

The contractor completed the park 271 days late, and the city notified the contractor that it was in breach of contract.

The city then filed a lawsuit against the contractor for breach of contract and alleged that the contractor did not timely complete its work. As a result, the city claimed it was owed $271,000 in liquidated damages for the 271-day delay in completing the project.

Both the city and the contractor filed summary-judgment motions. The contractor argued that the liquidated damages clause was an enforceable penalty and, of course, the owner argued the exact opposite. After considering the parties’ motions, the trial court granted the contractor’s motion for summary judgment and concluded that the liquidated damages clause was an unenforceable penalty.

On appeal, the court affirmed the trial court’s decision and concluded that the liquidated damages clause was an unenforceable penalty. The court reasoned that under Georgia law, a three-part inquiry must be satisfied to show the liquidated damages provision was enforceable. Specifically, the following three inquiries had to be satisfied:

  1. “the injury must be difficult to estimate accurately”;
  2. “the parties must intend to provide damages instead of a penalty”; and
  3. “the sum must be a reasonable estimate of the probable loss.”

The court noted that if any of the above three factors is lacking, the liquidated damages clause is an unenforceable penalty. The court’s decision focused on the second and third factors above.

The liquidated damages clause was intended to act as a penalty
The city argued that the parties did not intend the liquidated damages clause to act as a penalty. The court noted that since the contract lacked “any language indicating that the liquidated damages were not intended to be a penalty,” the court could look at evidence outside the language of the contract to determine the parties’ intent.

During a deposition of the city’s corporate representative, the city testified that it was important to build the new park on time because the old park would have to be demolished before the new park could be built, and the residents in the area would have to go to a park further away. Thus, the city “agreed that the intent of the [liquidated damages] clause was to ‘disincentivize delay’ with the project ‘[b]ecause [the contractor] is going to have to pay $1,000 a day out of their net profits if they don’t get the project done on time.'”

Based on that testimony, the court found that there was evidence that the liquidated damages clause was included in the contract for the purpose of deterring one of the parties from breaching it and, as such, it is a penalty.”

There was no reasonable estimate of probable loss
The court also reasoned that even if the liquidated damages clause was not intended to act as a penalty, the clause failed because there was no evidence that the $1,000 per day penalty was “a reasonable estimate of the probable loss resulting from a delay in construction of the park.” The court also cited a case stating that before executing an agreement, there must be an attempt to estimate the damages resulting from a potential breach.

The city argued that the liquidated damages clause should be upheld because the $1,000 daily liquidated damages rate was less than .0004% of the total project cost, and the damages “reflect the time-value of performance by a date certain.” The court rejected that argument because Georgia law “‘requires pre-estimation,’ and there is no evidence in the record that, prior to execution of the Contract, the City attempted to estimate damages resulting form late completion of construction.”

The court noted that the city representative testified “that the $1,000 per day number was not project specific, but was instead a ‘standard’ number.” Thus, the court concluded that “the amount of liquidated damages plainly has no reasonable relation to any probable actual damage which may follow a delayed completion of the project, and the [liquidated damages clause] is unenforceable.” As such, the court affirmed the trial court decision.

Bottom LineAs I have written previously, to increase the chances that a liquidated damages clause will be enforced, the owner should make a pre-estimate of probable actual damages that will be incurred due to the contractor’s late completion of a project. It would also be ideal to include language in the contract that indicates the parties do not intend the liquidated damages to serve as a penalty.

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