For the Client: Liquidated Damages Give Reason for Caution

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October 2011

COMMUNITIES: PRIVATE PRACTICE
For the Client: Liquidated Damages Give Reason for Caution

BY NAHOM A. GEBRE, ESQ., P.E.

NAHOM A. GEBRE, ESQ., P.E.Clients often face situations where the consequences of not completing a project on time are very costly. The prospect of a delayed project often drives clients to include a liquidated damages provision in their construction contracts; however, these provisions are unwise for a number of reasons.
 
A liquidated damages provision stipulates the amount of damages suffered by one party when the other party breaches its contractual obligation. These provisions are enforceable when it is difficult to determine the amount of actual damages due to the breach. In most jurisdictions, the provision cannot allow for the recovery of actual damages as well. For the liquidated damages provision to be enforceable, it must provide some clear or readily ascertainable amount accruing because of the breach.
 
Generally, courts have held that the amount of liquidated damages must bear some reasonable resemblance to the actual damages that might be suffered, and the amount set as a liquidated damage cannot be irrespective of the actual impact of the breach of contract. Courts have consistently held that a liquidated damages provision cannot be used to impose a penalty.
 
Liquidated damages provisions are useful to clients in certain construction contracts between clients and contractors when meeting the completion date is important to the client. The plans and specifications prescribe a clear definition of the work, so it is relatively easy to determine when construction is completed. It could be defined as the date of substantial completion, the date of beneficial occupancy, or some other measurable completion milestone.
 
However, when a liquidated damages clause is placed in a contract with an engineer, it creates a contractual liability that is not easily managed by the engineering firm. Engineering firms are generally tasked with producing instruments of service that have sufficient information to allow the contractor to construct the project. Completion of the instruments of service often depends on items beyond the control of the engineer. This could include timely completion of work by others that are contracted directly by the client (e.g., geotechnical investigations, surveys), obtaining necessary site control and easements, securing necessary permits from various agencies and unforeseen conditions that alter the original design assumptions. Establishing a date of completion for professional services is not easy considering the nature of the work the engineer undertakes.
 
A liquidated damages clause can also impact the quality of the design. Engineers may feel compelled to deliver their instruments of service to meet the stated deadline to avoid paying liquidated damages—even if the drawings are not yet completed. The client may ultimately be better served by professional services that are completed with sufficient information for the contractor to complete the project rather than a set of documents that have been delivered on time with insufficient information. A liquidated damages provision may present the engineering firm with a conflict of interest between their desire to provide an adequate set of instruments of service that meets the client's needs and their wish to avoid paying liquidated damages.
 
Engineering firms are required to provide professional services in a manner that meets the standard of care, which is commonly defined as an obligation to provide services with "the skill and care used by members of Engineer's profession practicing under similar circumstances at the same time and in the same locality." One of the key provisions of this clause is that the quality of the services provided is examined under similar circumstances that prevailed during the course of the project. A liquidated damages provision triggered by a failure to meet a specified date does not take those circumstances into account. Those circumstances are a key element of the standard of care expected of design professionals, and since a liquidated damages clause is not related to negligence in the performance of professional services (not meeting the standard of care), the professional liability insurance policy would not respond. Most professional liability policies specifically exclude coverage for liquidated damages.
 
Clients obviously have a legitimate interest in making sure engineers meet established milestones and deadlines. Ideally, the client and engineer should jointly develop the schedule based on the realities of the project and that takes into account unforeseen conditions and elements outside the control of both the client and engineer. The engineer should then strive to meet the established milestones, and periodically inform the client of any issues that affect the time of performance. The client has to be amenable to time extensions due to factors outside the control of the engineer; this ultimately serves the best interest of the project. The engineer's contractual obligation should be limited to perform as expeditiously as is consistent with professional skill and care, a formulation that makes it clear that any particular facts and circumstances that may affect timely performance are taken into account.
 
In summary, a liquidated damages clause is not appropriate for design services and jeopardizes the available coverage of the professional liability policy.
 
Nahom A. Gebre, Esq., P.E., is a risk management attorney for Victor O. Schinnerer & Co. Inc. CNA/Schinnerer's professional liability insurance program has been commended by NSPE since 1957.