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Liquidated Damages: Documenting the Basis for Damages for Late Completion

  

This is the second in a three-part series on liquidated damages in construction contracts. The first part addressed the various types of damages and how liquidated damages should be determined and specified. This post presents an example of documenting the basis for liquidated damages. The final part will address enforcing liquidated damages during construction.

The basis for liquidated damages, and any other damages to which the contractor will be subject for late completion, should be documented in a design stage memo retained in the project files of the owner, design professional, and construction manager as advisor (CMa, if any). Such documentation will likely be critical to establishing the enforceability of such damages if challenged by the contractor in a claim or dispute.

Such documentation may be prepared by the owner, design professional, or CMa. It should be presented in sufficient detail to convincingly demonstrate to the contractor itself and, if subsequently necessary, to an impartial third-party, whether an initial decision-maker in a claim, an arbitrator, or a judge and jury, that the contractual damages were a rational estimate of the damages the owner reasonably expected to incur due to the contractor’s late completion.

If the construction contract also imposes other types of damages, such as “special damages” or performance damages, these should be defined in detail in the contract itself. In some cases it will be useful to provide comments or an explanation of the context for such damages in the damages memorandum.

Presented below is an example of such documentation, originally drafted in 2010 for a construction contract that incorporated EJCDC C-520—2007, Agreement between Owner and Contractor on the Basis of Stipulated Price, and EJCDC C-700—2007, General Conditions of the Construction Contract. The construction contract included, and the example memo addresses:

  1. Liquidated damages for late completion of an interim milestone.
  2. Liquidated damages for failure to achieve substantial completion within the stipulated contract time.
  3. Special damages (i.e., the owner’s actual costs incurred for engineering, resident project representative (construction observation), and owner-hired special inspection and testing laboratories) for failure to complete all the work and be ready for final payment by the stipulated contract time.
  4. Performance damages (to compensate the owner for the 20-year present-worth cost of electricity use for under-performing major equipment, as determined under controlled conditions at the factory).

Basis-of-damages documentation for other projects will, of course, differ from the example presented below and no representation is made that the following example is suitable or appropriate for any other project.

Although the project from which the example memo, below, was obtained was not subject to civil fines or penalties from authorities having jurisdiction, such amounts, if reasonably known in advance, could have been included in the liquidated damages amount  or, alternatively, included in a clause on special damages.

Example Memorandum

Date:                     [Date]

To:                          [Owner Contact 1]

[Owner’s Attorney]

Copy:                    [Engineer Team Member 2]

[Engineer Team Member 3]

From:                    [Engineer Team Member 1]

Re:                         [Owner’s Organization Name]

[Project Designation]

Construction Contract Damages Provisions

This memorandum sets forth the rationale for the construction Contract Documents’ provisions for financial damages for late completion by the Contractor.

The Owner-Contractor Agreement will include a provision for the Contractor to compensate the Owner for damages associated with the Contractor completing the Work beyond the Contract Times.  Liquidated damages for late completion will be based on our estimates of the following:

  • Amount of electrical operating cost savings to be provided by the new blower equipment to be provided under the Project.  Late completion by the Contractors will therefore result in increased operating costs for the facility compared to the cost of electrical power if the construction is completed within the Contract Times.  The probable first-year electrical cost savings of approximately $130,000 equates to approximately $356 per day.
  • Potential delay costs incurred by a prime Contractor due to the delay of another prime contractor. The following estimate of costs is based on a delay Claim potentially submitted by a prime  Contractor, based on our prior projects for your organization and the types of delay costs previously submitted by contractors on certain, prior projects:

Cost Item

Quantity

Units

Unit Cost

Total Cost

Labor - Foreman

8

hours

$50.00

$400.00

Labor – Mechanic or electrician

8

hours

$40.00

$320.00

Labor - Apprentice mechanic or apprentice electrician

8

hours

$25.00

$200.00

Rental - Tool truck with equipment

8

hours

$50.00

$400.00

 

 

 

 

 

Subtotal

 

 

 

$1,320.00

Division 01 costs

 

 

10.0%

$132.00

Overhead and profit

 

 

17.0%

$224.40

Total Estimate

 

 

 

$1,676.40

 

  • Other reasonably-foreseeable costs of delay, if any, can be incorporated but we do not currently foresee such costs.  If you are aware of additions to the estimate of damages that would be incurred by the Owner due to late completion by the Contractor, please so advise us by [date].
  • Accordingly, the total estimated damages are comprised of the cost of electricity ($356 per day) and the potential estimated delay Claim ($1,676 per day) by another prime contractor, for a total of approximately $2,032 per day. 

In addition, the Owner-Contractor Agreement (developed from EJCDC C-520—2007) will include a provision for “special damages” that will require the Contractor to compensate the Owner for the cost of engineering and inspection incurred after the Contract Time for readiness for final payment.  Special damages do not apply to the other Contract Times because it is anticipated engineering and inspection costs will normally be incurred anyway until final completion. Although the amount of such special damages for engineering forces can vary significantly, depending on the extent of engineering services required, for similarly sized, previously completed projects “in-office” engineering services were often approximately $1,000 per day, and Resident Project Representative (RPR) services (for the Engineer’s staff onsite for construction observation and monitoring) were often approximately $800 per day, depending on the employee grade required for RPR services.  It is currently unknown whether the engineering effort incurred by the Owner due to the Contractor’s late completion would be less than, equal to, or greater than the amounts presented above.  We currently anticipate that RPR services for the Project will not be full-time, but on days when the RPR is onsite it is likely a full day of services will be necessary.  The number of days per week the RPR would be onsite will depend on the nature of the Work ongoing at that time.

The cost of Owner-hired, third-party special inspectors performing code-required tests and special inspections depends on the project and type of work underway at the time such testing or special inspection is required and cannot be reasonably or accurately estimated in advance as a basis for damages for late completion; a schedule of costs and rates is in the most-recent authorization by [Owner’s organization name] to [testing entity name] for [name of prior project].  Also, additional costs to the Owner for code-required tests and special inspections do not necessarily result from late performance; rather, added costs to the Owner typically result from retesting work initially determined to be defective. Often, the Owner’s costs for such tests and inspections are the same regardless of whether the Work is completed within the Contract Times.

The Owner-Contractor Agreement for each prime Contract will include the following Contract Times:

  1. Milestone for placing the new blower equipment, electrical equipment and systems, and other Work into operation (i.e., Substantial Completion of the new equipment and systems).
  2. Substantial Completion of all remaining Work (i.e., all Work ready for its intended use, including completion of demolition of existing blower equipment and restoration of building spaces).
  3. All Work completed and ready for final payment (i.e., “final completion”).

We recommend apportioning damages as follows:

  1. Milestone: Damages for cost of electricity ($356 per day); we recommend rounding off this amount to liquidated damages of $360 per day.
  2. Substantial Completion of all Work: Damages for delaying the Work ($1,676 per day); we recommend rounding off this amount to liquidated damages of $1,600 per day.
  3. Final Completion: Special damages (only) as described above.

We believe the recommended damages presented above are both reasonable and will protect the Owner in the event the Work is completed beyond the Contract Times.  Should you prefer alternative damages provisions, please contact [Engineer Team Member 1] at [phone number and e-mail address], by [date].

In addition to the foregoing, should the new blower equipment be determined, based on the results of controlled testing at the blower equipment manufacturer’s factory or testing facility, to perform at less than the required performance, including energy efficiency, the construction Specifications for the new blower equipment will include provisions for the General Contractor (i.e., the contractor providing the new blower equipment) to compensate the Owner an amount equal to the 20-year-present worth cost of the electricity consumption, based on the difference between the blower equipment shop test results for each individual blower and the specified performance in the equipment Specifications, based on four blowers operating 24 hours per day, 365 days per year. The equipment Specifications’ provisions on such performance damages will expressly indicate the current electrical rate paid by the Owner, based on the Owner’s current electric bills, a reasonable assumption for escalation in electrical power costs, and an assumed interest rate. The blower equipment Specifications will include example calculations and a table of pre-calculated damages amounts for certain shop test results.

The Owner-Contractor Agreement will include a provision expressly allowing the Owner to withhold from payments due the Contractor amounts for liquidated damages, special damages, and, for the General Contract, blower equipment performance damages.

Conclusions

This blog post has presented a basic example for documenting the basis of liquidated and special damages in a construction contract. Such documentation should be specific to the project and retained in the files of the project owner, design professional, and construction manager as advisor (if any) and should be written to be used as an exhibit in litigation or arbitration.

The forthcoming, final post in this series will address enforcement of liquidated damages clauses during construction.

Acknowledgments: The author gratefully acknowledges Jerry Cavaluzzi, Esq., vice president and general counsel of Kennedy/Jenks Consultants; Jim Brown, PE, CSI, CCCA, vice president in construction management at Arcadis; and Hugh Anderson, Esq., attorney-at-law and general counsel to EJCDC, for reviewing and commenting on drafts of this post.  

Copyright 2021 by Kevin O’Beirne

The content of this blog post is by the author alone and should not be attributed to any other individual or entity.

Kevin O’Beirne, PE, FCSI, CCS, CCCA is a professional engineer licensed in NY and PA with over 30 years of experience designing and constructing water and wastewater infrastructure for public and private clients.  He is the engineering specifications manager for a global engineering and architecture design firm.  He is a member of various CSI national committees and is the certification chair of CSI’s Buffalo-Western New York Chapter.  He is an ACEC voting delegate in the Engineers Joint Contract Documents Committee (EJCDC) and lives and works in the Buffalo NY area.  Kevin O’Beirne’s LinkedIn page

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