Monday, October 21, 2013

What You Need to Know About Liquidated Damages

Most public works contracts include a provision giving the public agency the right to assess liquidated damages against the contractor, usually a fixed dollar amount for each day the contractor fails to complete the work by the agreed upon date for substantial completion.

Why include Liquidated Damages?  Liquidated damages is a tool that public agencies may use to help ensure that the contractor performs the work consistent with the schedule in the contract documents.  Liquidated damages are intended to fairly compensate a public agency for costs that may be incurred by the contractor's failure to complete the work in a timely manner.

Establishing the Liquidated Damage amount:  It is not normally possible to determine ahead of time what the actual costs may be for a public agency in the event of the contractor's delay in completing the project.  In establishing the amount of liquidated damages to include in the bidding documents and contract, public agencies should go through a process to estimate what their costs might be.  In other words, there should be some rational basis for the amount of liquidated damages.  Some common factors that often go into establishing the liquidated damage amount include the following:
  1. Temporary facility costs for the public agency if the project is not completed on time
  2. Administrative staff costs of managing the project for a longer period of time
  3. Additional fees paid to the designer (architect/engineer) or a third party construction manager required to provide services for a longer period of time
  4. Revenue loss for the public agency if the facility is not completed in a timely manner
  5. Temporary systems and security for the project (e.g. fire watch)
  6. Agency costs for additional storage time for furniture or equipment
  7. Regulatory financial sanctions against the public agency for failure to meet a deadline
Can Liquidated Damages be too high?   Yes, liquidated damages, even when calculated based on likely costs, may be too high.  In establishing the per day amount for liquidated damages based on potential costs, public agencies should evaluate the reasonableness of the amount, and the potential risks of an amount that is too high.  Factors to consider in establishing the liquidated damage amount include the following:
  • Don't discourage bidding:  Not so high that it either discourages bidders from bidding the project.
  • Don't risk higher bids:  Not so high that it encourages bidders to submit higher bid prices to mitigate their perceived risk in being potentially assessed the liquidated damage amount.
  • Incentive for timely performance:  Should be a sufficient amount so that it serves as an incentive for the contractor to complete the work on time.
When does "substantial completion" occur?  Liquidated damages may be assessed up to the required substantial completion date.  Substantial completion occurs when the public agency has beneficial use and occupancy of the facility for its intended purpose.  Not all of the punch list work must be completed, but the owner must be able to actually use the facility.

Assessing liquidated damages:  Many public agencies are hesitant to actually assess liquidated damages against a contractor even if the contractor is late in completing the work.  The reasons for a delay in completion must be documented in order to make a case to assess liquidated damages.  To the extent that any of the delays are not the fault of the contractor, the public agency should grant an extension of time.  All completion past the required date of substantial completion should be accounted for either through the use of liquidated damages, and/or granting an extension of time.

Practical tips:
  • Worksheet:  Develop a worksheet to help you calculate liquidated damages to include on each project.
  • Fair Liquidated Damage amount:  Conduct a risk analysis for each project to make sure the liquidated damage amount is neither too high nor too low.
  • Keep records:  Maintain careful records during construction to document contractor delays.
  • Assess damages and/or grant days:  Account for all of the late completion days after the required substantial completion date by either assessing liquidated damages, and/or granting an extension of time for some or all of the days.
Note:  This blog posting is a repeat of one from February 25, 2013. 
Mike Purdy's Public Contracting Blog 
© 2013 by Michael E. Purdy Associates, LLC

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