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Liquidated damages — who do they really protect?

Question: I am the risk manager for a general contractor and we have been asked to bid on a project to build a four-story hotel with a total of 150 rooms. My job is to look over the scope of work and the contract documents to determine if we should pursue the work and submit a bid. While the project is well within our capabilities, I am uncomfortable with some of the contract terms — specifically the liquidated damages clause. If we do not complete the project by the contract deadline, we would be assessed a penalty of $15,000 per day. That seems excessive based on the fact that this is a chain hotel and the general plans have been used successfully in several other property locations. The other concern is that the project schedule is very tight and the hotel is in a tourist resort area. We would be contracting directly with the owner, who is a commercial developer, and at the same time we would be taking directions from the architect, who has been hired by the owner to modify the plans and specifications to meet local conditions. Should we bid on the project anyway and then try to negotiate the liquidated damages clause out of the contract to make it more favorable for us?

Answer: Whether or not you should be worried about liquidated damages depends on more than the value of the liquidated damages. For example, your concern about possibly not making the project schedule deadline is valid. As you know, any number of things can cause delays such as weather delays, more underground boulders than expected, and even uncommon things like bee infestation of the jobsite. It is always a bit of a gamble, especially when time is limited, so you need to look at the contract to see what excusable delays are allowed when you are assessing your risk of being assessed any delay damages. Also, that the plans have been used successfully in other locations is somewhat reassuring, but is no guarantee that they will transfer flawlessly to your locale. It feels like a penalty, but is it? Your comment was that liquidated damages are a penalty. You and the owner both want to have the project completed on time because delays cause damages to the contractor as well as the owner. You are probably used to claiming delay damages in the form of additional general conditions, extended overhead and additional jobsite expenses if the owner delays the project. The owner will also incur damages due to a delay, but often its damages are addressed as liquidated damages. Liquidated damages are merely a predetermined amount that both parties agree will the owner suffer the damages if the contractor delays the completion. Where the amount of actual damages that could be incurred is uncertain and not easily ascertained, it makes sense to know ahead of time what the damages will be if there is a delay. Usually the delays are assessed on a per day basis. If you don’t make the project deadline, and it is your fault, you will owe the owner the per-day rate for every day of delay. In reality, the owner is telling you what the owner believes will be the value of the damages caused by missing the deadline. But, is this a penalty? It may feel like it, but today, liquidated damage clauses are very common. However, prior to 1977, California courtswere reluctant to enforce liquidated damage clauses because they too believed them to be a penalty. But the law changed and now liquidated damages are presumed not to be a penalty unless the person fighting them can prove that they were “unreasonable under the circumstances existing at the time the contract was made.” (Civil Code §1671(b)). Be careful what you wish for. I am assuming you want to have the liquidated damage clause removed because it probably seems like an unfair threat. Let’s analyze your situation. You are looking at $15,000 per day for every day that the owner is not able to use his property. This is a hotel with 150 rooms, and in a popular tourist area, the project schedule is tight in order for the hotel owner to be open for business the during tourist season. It would be reasonable to expect that the rooms go for least $230 per night and it is not unusual to have sold out conditions in tourist areas. Multiply the expected room rate times the number of rooms and the amount per day that the hotel can realistically bring in is $34,500. Even assuming one-third of the revenues are used up with costs to run the hotel, there is a loss of net profits of $23,000.This does not take

into account any other money making amenities such as the bar or restaurant. Compare that amount with the liquidated damages of $15,000 per day, and you can see that the amount is not unreasonable. In fact, it is much less than the hotel owner can expect to loseperday. If there were no liquidated damages clause, the owner would be able to seek actual damage delays. This means the $23,000 in lost profits for rooms that could not be booked, but also interest on construction loans, extended overhead, and a number of other justifiable expenses that the owner will incur every day that the project is late. Also, with a liquidated damages clause, the owner can’t choose to assess actual damages when it finds out that the liquidated damages don’t cover what they are really losing. Knowing this, the liquidated damages clause doesn’t look too bad — and actually seems pretty good. If you have a construction question, submit it to: info@constructionlaws. com • • • Disclaimer The information in this article is based upon California law and is for general information only. Any information or analysis presented here is intendedsolely to inform and educate the reader on general issues. Nothing presented or referenced to, regarding facts, documents or applicable laws, constitutes legal advice. Before acting or relying on any information, including any information presented here, consult with a qualified attorney for your specific situation. • • • Scholefield holds an active PE license in Colorado, an undergraduate engineering degree from the University of Florida, and received her JD from the University of San Diego. Source Code: 20080404tcb

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