The contractor on your project is behind schedule and will not comply with the contract times. The construction contract has a liquidated damages clause. Now what? How does the owner get compensation for its financial damages?
“Show Me the Money!”
Before attempting to impose liquidated or other damages included in the contract, the design professional or construction manager as advisor (CMa) should review the owner’s contractual rights for obtaining such compensation. Many non-standard construction contracts reviewed by this writer require the contractor, “shall pay the Owner” or, “is liable to the Owner”, or, “shall owe the Owner” liquidated damages. “Owing” means, “I’ll pay you someday’; “shall be liable” is more-clear but still does not address how the owner obtains compensation; and “shall pay the Owner” implies the contractor will issue a check to the owner, which is unlikely in actual practice. In all of these cases, the owner may conclude it is in a gray area where it may be obligated to continue to pay the contractor’s progress payments, even though the contractor is beyond the contract time and the owner will ultimately be contractually entitled to recoup damages.
Owners obviously prefer a more straightforward approach, such as the contractual right to withhold liquidated and other damages from payments due the contractor. To this end, Paragraph 15.01.E.1.j of EJCDC C-700—2018, Standard General Conditions of the Construction Contract, establishes:
“E. Reductions in Payment by Owner
“1. In addition to any reductions in payment (set-offs) recommended by Engineer, Owner is entitled to impose a set-off against payment based on any of the following:
“j. Liquidated or other damages have accrued as a result of Contractor’s failure to achieve Milestones, Substantial Completion, or final completion of the Work;”
Even when the owner has the right to withhold liquidated and other damages from payments due the contractor, a change order is eventually necessary to officially reduce the contract price by the required amount. Because a change order typically requires the signatures of both the owner and contractor to be effective, the potential exists for the contractor to attempt to stymie the owner’s reduction of the contract price for liquidated or other damages by refusing to sign the change order. To avoid such situations, EJCDC C-700—2018, Paragraph 11.02.B, states:
“B. If Owner or Contractor refuses to execute a Change Order that is required to be executed under the terms of Paragraph 11.02.A [which, among other things, requires change orders to finalize changes in the contract price for owner-imposed set-offs], it will be deemed to be of full force and effect, as if fully executed.”
Section 22.214.171.124 of AIA A201—2017, Standard General Conditions of the Contract for Construction, empowers the architect to reduce the amount eligible for payment due to liquidated damages, as follows:
“§ 9.5 Decisions to Withhold Certification
“§ 9.5.1 …The Architect may also withhold a Certificate for Payment [to Contractor] or, because of subsequently discovered evidence, may nullify the whole or a part of a Certificate for Payment previously issued, to such extent as may be necessary in the Architect’s opinion to protect the Owner from loss for which the Contractor is responsible, including loss… because of
“.5 damage to the Owner or a Separate Contractor;
“.6 reasonable evidence that the Work will not be completed within the Contract Time, and that the unpaid balance would not be adequate to cover actual or liquidated damages for the anticipated delay;”
While AIA A201 allows the architect to reduce the eligible amount of payment to the contractor for liquidated and other damages, A201 does not allow the owner to withhold such payment on the owner’s initiative. However, as further discussed below, the architect should never unilaterally withhold payment for such amounts without first consulting with the owner and obtaining the owner’s direction on whether and when to withhold payment. A201 also does not address the potential for the contractor to withhold its signature from a change order that reduces the contract sum because of liquidated or other damages.
Contractors often take exception to withholding payment. Indeed, a frequent source of contractor claims is an owner’s alleged wrongful withholding of payment. Because the owner’s right to withhold payment for liquidated and other damages is so critical, for maximum clarity, this writer also prefers to include the following in the Owner-Contractor Agreement, at the end of provisions on liquidated and special damages:
“#.## Owner reserves the right to withhold from payments due Contractor under the Contract amounts for liquidated damages (if any), special damages (if any), and performance damages (if any) in accordance with the Contract.”
To contest withholding of liquidated or other damages, the contractor’s recourse in AIA A201 is a claim. In EJCDC C-700, the contractor may contest a set-off via a change proposal. If the contractor disagrees with the engineer’s decision on the change proposal, the contractor may submit a claim directly to the owner.
Communication and Documentation
On many projects in which this writer has advised design professionals and owners, it is surprisingly common for there to be a lack of documentation of construction delays. Often, “everyone” on such projects is aware the work is behind schedule, but the owner and design professional have not affirmatively asserted their position or the owner’s rights to compensation for damages.
In such cases, it may appear the contractor proceeded without implementing substantive, corrective actions to recover the lost time. After all, efforts to recover lost time typically result in added costs to the contractor. The contractor may proceed in a seemingly unhurried manner expecting a forthcoming change order extending the contract times. On many such projects, the contractor may become outraged when “suddenly hit with” news the owner might exercise its rights to contractually stipulated damages. This may set the table for claims, counterclaims, and substantive disagreements.
While it is unlikely all contractors in all late projects can be mollified by words alone when facing withheld payment for late performance, the owner typically has improved potential to successfully exercise their contractual rights when communication is clear, documented, and timely, as further discussed in the next section of this blog post.
The project’s compliance with the contract times and construction schedule is a common topic at construction progress meetings. When the project is behind schedule, discussions at such meetings and the associated meeting minutes should generally follow the advice, presented below, for letters to the contractor concerning late performance.
The purpose of written communications on late performance is to ensure the contractor has a clear understanding of the owner’s, design professional’s, and CMa’s position on the delays; to document the causes of delays; indicate the owner’s recognition of its rights to damages; to furnish the contractor with an estimate of the time delay and the associated, estimated contractual damages; and to remind the contractor of its responsibilities. Again, withholding payment for damages should never be a surprise to the contractor.
When the work is behind schedule for a prolonged period, multiple letters to the contractor may be appropriate, especially when the delay increases. The frequency that such letters should be furnished varies, but likely not more often than once per month is sufficient, unless significant delays occur.
To be balanced against this is the potential of over-communicating the unwelcome accusation, “You’re late, it’s all your fault and, boy, it’s going to cost you dearly.” The written communications discussed in this blog post, regardless of how well-written, professional, impartial, and sympathetic, may provoke the contractor and contribute to deteriorated relationships on the project. Even when the contractor is entirely at fault for the delays, such communications are likely to be viewed as the design professional or CMa nailing the lid shut on the contractor’s coffin while the contractor is still alive. Appropriate judgment of the dynamic situation and personalities involved, and application of what psychologists call, “emotional intelligence”, are necessary.
Professionally Performing an Unpleasant Task
Reducing payment to the contractor from the requested amount is a very serious matter that may adversely affect the contractor’s cash flow and ability to pay its creditors and, possibly, its relationship with its surety. It has strong potential to provoke an adverse reaction from the contractor and may have a detrimental effect on relationships on the project. Therefore, it should never be undertaken lightly or without careful consideration of all its likely impacts.
A design professional or CMa should never unilaterally reduce payment to the contractor, regardless of how much the contractor is, or appears to be, behind schedule and responsible for the delays. Because of the serious ramifications of reducing payment to the contractor, the owner must be consulted and ultimately decide whether to, and when, to withhold payment from the contractor for contractually stipulated damages. All entities on the owner’s team should participate in the discussion: owner’s project manager and legal counsel, design professional, CMa (if any), and owner’s program manager (if any).
Simply because the owner has a contractual right to withhold payment for liquidated or other damages does not necessarily mean the owner must exercise its rights. Where an owner has sufficient funds, discretion is necessary in deciding whether to exercise such rights. An owner that acquires a reputation among contractors for frequently withholding payment because of late performance may see increased bid prices on future projects. Repeated, short-term attempts to be “made whole” may result in greater long-term costs to the owner. Finally, accrued liquidated damages may be used as a bargaining chip in negotiating other, unrelated changes with the contractor; for example, the owner may offer to waive imposing liquidated damages if the contractor agrees to drop an unrelated claim for differing site conditions.
Conversely, not clearly asserting the owner’s rights and, in certain cases, exercising its rights, may result in the owner’s later attempt to recover such amounts possibly being deemed unenforceable; thus, the owner also should avoid having a reputation of “never” enforcing liquidated damages. The existence of such nuances reinforces the need for the owner to consult with qualified legal counsel.
The timing of actual withholding of payment should be judged for each project. The contractor’s total liability for contractual damages and other set-offs to which the owner may be entitled should not exceed the unpaid balance of the contract price. For example, if the total accrued liability for damages for late completion and other set-offs is $50,000 and the unpaid balance of the contract price is $500,000, it may perhaps be premature to start withholding payment. On the other hand, if the total accrued liability for late completion and other set-offs is $50,000 and the total unpaid balance of the contract price is $25,000, the horse may already be partly out of the barn.
When the owner determines that amounts for damages should be withheld from the contractor’s payments, it should not come as a surprise to the contractor. Projects almost never fall behind schedule overnight; rather, the signs and slippage are noticeable and usually fairly obvious for some time before matters progress to the point of withholding payment. During this period, it is necessary to document the schedule slippage via appropriate, written communications.
The design professional’s or CMa’s written communications to the contractor that the project is behind schedule and apparently may not or will not be completed within the contract times should be:
- In writing.
- Employ language and tone that is professional, guarded, impartial, and avoids controversial or unsubstantiated accusations. In certain situations, a sympathetic tone may be appropriate.
- On letterhead rather than other, less formal types of communication, like e-mail. Communications under letterhead may perhaps be declining in popularity but nevertheless carry, in this writer’s opinion, more gravity and communicate increased formality for important matters.
- Indicate the writer’s opinion of the reasons for the delays, supported by citations of specific facts in the project record. Citations to the contract’s allocation of risk of delays is usually appropriate, including AIA A201—2017 Section 8.3 and EJCDC C-700—2018 Paragraphs 4.05 and 11.08. https://www.csiresources.org/blogs/kevin-obeirne-pe-fcsi-ccs-ccca-cdt1/2021/09/01/liquidated-damages-compensation-for-late-completio?CommunityKey=80c3b4dd-0d3f-4d4e-90f2-3bc6e4135dc2
- Indicate the number of days the writer believes the work will be completed beyond the contract times.
- Include a reminder of the owner’s rights to liquidated and other damages, if any, in accordance with the contract and, often, a statement of the writer’s opinion of the total amount of the contractor’s liability for such damages.
- Urge the contractor to do all in its power to recover the lost time, including preparing and implementing a recovery schedule, and to complete the work either within the contract times or, if that appears to be no longer feasible, as close to the contract times as possible. A reminder that the contractor has full responsibility for compliance with the contract times and for construction means, methods, procedures, sequences, and techniques, may also be appropriate.
In preparing such communications, the design professional or CMa should understand there are two sides to every story and the contractor’s view of why the work is behind schedule may be very different from the opinions of the owner, design professional, and CMa. That the contractor’s view may have merit must be considered impartially and, where some or all of the delay resulted from causes beyond the contractor’s control, an appropriate change order should be promptly issued. Time extensions should not build up for resolution in a final change order.
Taking extreme or unreasonable positions on causes of delays helps no one. Ultimately, if the parties cannot amicably resolve their disagreement, a court or arbitrator will impartially decide the matter, after the parties have incurred significant stress, lost time, attorneys’ fees, and other costs. It is often best for all participants to be reasonable from the outset regarding causes of delays.
The advice presented above, concerning written communications, also largely applies in oral discussions between project participants. Whether during in-person discussions, in meetings, or on telephone calls with the contractor, the owner, design professional, and CMa should always endeavor to be professional, impartial, and properly informed concerning project events and contractual requirements.
Alerting the Surety
When the contractor has furnished a performance bond and the work is beyond schedule, occasionally, the owner or one of its consultants may believe it necessary to copy the contractor’s surety on written communications concerning delays. This should be done rarely and only in extreme cases, where the work is so far behind schedule that the owner is seriously contemplating terminating the contractor for cause. Copying the surety should never be done casually or without due consideration of its likely effect on the contractor. The owner’s legal counsel should be involved in the decision to copy the surety on such communications.
On the negative side, copying the surety on such correspondence is likely to provoke an adverse reaction from the contractor. Because of the indemnity agreement between the contractor and its surety, in the event the contractor is terminated for cause and the surety has to fulfill its performance bond obligations, the contractor will be liable to the surety for the surety’s costs, which could involve the loss of the contractor’s personal assets.
On the positive side, advising the surety of a delayed, troubled project at an appropriate time may result in the surety intervening to assist the contractor, to avoid a termination for cause. When the surety intervenes in this manner, it often provides guidance to the contractor and expertise in recovering the project.
Alerting the surety should be done only as the last step before the owner truly intends to exercise “the nuclear option”.
Notice of Withholding Payment
When payment to the contractor is reduced for any reason, including exercising the contractual right to withhold payment for liquidated or other damages, it is always appropriate and, in many cases, an express, contractual obligation, for the contractor to receive formal, written notice of the reduction. Such notice should be furnished promptly, especially when contractually stipulated time limits (often, 10 days after receipt of the application for payment) apply for issuance of such notices.
Before enforcing the owner’s rights to liquidated and other damages, the owner, design professional, and CMa should have a thorough understanding of the contract’s provisions on withholding payment, the psychology of the situation and personalities involved, and should properly document the causes of delay and its estimated consequences. In certain situations, the parties should consult their respective legal counsels. Discussions, whether oral or written, of delays should always be professional, impartial, and based on facts. Change orders extending the contract times should be promptly issued when the cause of the delay was outside the contractor’s control. Failure to comply with these recommendations may result in disagreements, claims, disputes, and their related unpleasantness.
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.
The author of this blog post is not an attorney and nothing in this blog post represents legal advice. Readers needing such advice should consult with qualified, experienced legal counsel.
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.