Liquidated damages in a construction context.

Can a liquidated damages clause help insure timely completion of a construction project? What are some of the benefits and pitfalls of such a clause? These and other issues revolving around liquidated damages are dealt with in a recent, somewhat anomalous decision of the New York Supreme Court (Hunts Point Multi-Service Center, Inc. v. Terra Firma Construction Management & General Contracting LLC, NYLJ 9/9/ 03, p. 18, col. 4 (Sup. Ct. Bx. Co.) [the Hunts Point decision]).

In Hunts Point, the project owner brought suit to collect liquidated damages for its contractor's failure to meet contract-mandated dates for completing construction on two buildings.

The contractor argued that the liquidated damages provision should not be enforced because, among other things, (1) the liquidated damages constituted an improper penalty and (2) the owner's rights to claim such damages had been waived by virtue of the certifications of the contractor's requisitions for payment by the owner's architect in the period subsequent to the contract-mandated period.

The contractor also claimed that the owner's own certifications to its lender concerning the contractor's requisitions during this period should equitably estop the owner from assessing liquidated damages after the fact.

What is of greatest interest is the court's discussion of the waiver and estoppel issues. According to the court there, all an owner waives in permitting the contractor to complete beyond the contract-mandated completion date is a highly-technical one--the right to use the contractor's delay as a defense against the contractor's claim for contract balance due.

However, such waiver does not limit the owner's right to claim damages for late completion, the court held. Moreover, according to the court, even though the architect was the owner's agent for certain purposes, the architect's certification could not operate to waive the owner's right to claim damages for delay.

The court focused on the generality of the architect's contractual mandate in making the rather tenuous argument that the architect could not bind the owner where there was no contractual provision that specifically granted the architect the authority to waive a violation of the general contract on behalf of the owner. (1)

The court did focus on one contractual provision that allowed for a more cogent argument, namely, the provision of the General Conditions of the parties' agreement that states that the architect's certification for payment does not constitute acceptance of the work as being in accordance with the contract documents.

Nor would the owner's own conduct in certifying the legitimacy of the contractor's requisitions to the owner's lender preclude the owner from also claiming damages against the contractor, according to the Hunts Point court.

The contractor's contention here was that the owner should be precluded (or "equitably estopped") from making one claim to the lender and a contrary one to the contractor. Notwithstanding the substantial logic and appeal of this argument, the court dismissed it almost out of hand by using a form of "boot-strap" argument--despite what appears to be contrary conduct, the owner cannot be said to be "estopped" from making this argument because (1) caselaw permits owners to claim liquidated damages even after the completion deadline has passed and (2) the contract itself provided for the assessment of liquidated damages.

Given that (it is submitted) the reasoning of the Hunts Point court on the architect and owner certification issues is strained at best and disingenuous at worst, the question to ask is why this result?

At bottom, it appears that the court simply felt it needed to tread lightly where a contrary decision would leave the owner without any remedy for what were undoubtedly significant financial losses incurred, especially where, as here, reasonable liquidated damages had been set forth in the parties' agreement.

There are several lessons to be learned from this decision for both owners and contractors. The latter must keep in mind that even the more obscure language of the AIA General Conditions and other forms may not be ignored as mere "boiler-plate."

Courts can and will enforce these provisions, for example, those regarding non-waiver by owner and architect certifications as not constituting acceptance of the work, and they may thus serve to nullify owner conduct that appears to be contrary to the owner's belated position on such key issues as damages for delay.

A second, related lesson is that Courts will acknowledge the realities of the business marketplace, even if it appears to be contrary to the apparent conduct of the parties, if some contractual basis--however strained--can be located. In short, courts are loath to deprive a party of a monetary remedy, especially if one is prescribed in its contract. For owners, the Hunts Point decision acknowledges and confirms the legitimacy of the powerful liquidated damages remedy, while at the same time prescribing boundaries for this remedy (i.e., where they are grossly disproportionate to the actual damages likely to be suffered).

And, despite the favorable result in this particular case, the issue of proper enforcement of the remedy is clearly called into question. That is, the next court may not be so charitable where the owner has not carefully enforced its rights, and the owner might lose its remedy. A simple expedient might avoid that result, however: in the Hunts Point context, the owner might have avoided the waiver issue entirely if it had simply sent its post-completion-date payments to the contractor with a "reservation of rights" cover letter. (2)

For an owner deciding whether to include a liquidated damages provision in its construction contract, then, there are several factors to consider--especially whether such damages will likely compensate the owner for late completion, etc. But where such damages are reasonable (at least on their face) and are fairly applied, they will be enforced.

(1) Such a ruling ignores the practicalities of the marketplace where the architect will typically follow the owner's instructions on all issues, especially the certification of requisitions for payment.

(2) Language can be crafted appropriate for the project that concludes with verbiage such as "[t]his payment is without waiver of any rights Owner may have under the parties' Agreement to claim damages for delay, including without limitation the Owner's right to claim liquidated damages under Section--of the Agreement, all of which are expressly reserved."

Other reservations may be appropriate as well depending on the circumstances of the project.