Liquidated Damages are a variety of actual damages which often appears in a contract as title for a whole clause or section. Parties to a contract use liquidated damages when an amount is designated during the formation of a contract for the injured party to collect as compensation upon a specific breach especially, delayed completion, late delivery of report, poor field work performance or delivery of inaccurate data.
Liquidated Damages are not penalties, they are pre-determined damages set at the time that a contract is entered into, based on a calculation of the actual loss the client is likely to incur if the contractor fails to meet the completion date.
Liquidated Damages generally set as a fixed daily or weekly sum, although these may be more complex where the works are phased. However, it is important that the method of calculation is precisely and formally documented.
In Early Work Activities for Site Development Project contracts, when damages are not predetermined/assessed in advance, then the amount recoverable is said to be “at large” and must be agreed or determined by a court or tribunal in the event of breach.
Liquidated Damage clause is a useful tool that are currently being applied in Early Work Activities contracts. This is being done to forestall delay of Early Work activities programmes, which is critical for the Engineering design programme and reduce unforeseen expense for the Engineering Procurement Company (EPC) and Asset owner.
It is also normal in Early Works Activities to consider the use of liquidated damages clauses in contracts with sums over $75,000 and involves integrated data collection or when the project duration is above two months and delay could cause a loss in revenue if poorly performed.
Nevertheless, in Early Work Activities contracts, here are some of the criteria that may be considered when determining anticipated damages:
- Loss of revenue
- Bank Interest on borrowed money
- Added administrative overhead
- Additional consultant costs
- Inefficient use of company resources
- Loss of personnel or personnel time
- Cancellation cost of EPC design programme
- Costs for insurance, utilities, or equipment
- Advanced payment guarantees and indemnity costs.
Liquidated Damages can be beneficial for the client, as they remove their obligation to prove actual losses in the event of delay occurring. They can also be beneficial to the contractor as they limit their liability to a known amount in the event of delay. However, in some circumstances, the parties to the contract will wish to exclude liquidated damages. In this case, they should make it clear that unliquidated damages apply, or delete the clause for liquidated damages.
Despite all these measures, Liquidated Damages also have some inherent drawbacks:
- contractors tend to factor the risk of incurring Liquidated Damages into their price;
- contractors rarely accept uncapped liability for liquidated damages; and
- disputes can arise over the contractor’s entitlement to an extension of time (EOT), which at the very least is an administrative headache, and potentially may relieve the contractor of liability to pay liquidated damages.
However, under the Common Law, for a liquidated damages clause to be upheld, two conditions must be met.
First, the amount of the damages identified must roughly approximate the damages likely to fall upon the party seeking the benefit of the term. Second, the damages must be sufficiently uncertain at the time the contract is made that such a clause will likely save both parties the future difficulty of estimating damages. On the other hand, when Liquidated Damages are imposed as punishment for failing to keep contract terms, instead of covering unprovable damages, the clause is not upheld. When Early Works Activities are delayed by an unforeseen event that impacts on the completion date, that is not the fault of the contractor, then this may constitute a ‘relevant event’ for which the contractor may be granted an extension of time thus, relieving the contractor from a claim of liquidated damages.
A plausible alternative to Liquidated Damages, is a bonus or incentive system which focus the contractor on achieving completion of Early Work Activities on or before a stipulated date, rather than asking for EOT which breeds disputes.
Under a bonus or incentive scheme, there are many ways to structure such a scheme in an Early Work Activities contract, and these include:
- A ‘hard date’ for completion of Early Work Activities such that the contractor is entitled to the incentive payment if completion is achieved on or before a specified date, but if the date is not achieved, the contractor receives no incentive payment.
- A progressive reduction in the incentive payable if completion occurs after the specified date.
- A milestone system whereby the contractor is offered an incentive payment for each portion of the works that is completed on time. In this situation, the incentive could be structured so that if one incentive milestone is not achieved on time, the contractor can still “earn” that incentive payment by rolling the payment over into a later incentive payment linked to achievement of a subsequent milestone payment.
From the above it is apparent that, the appropriate incentive scheme will depend on the nature of the Early Work Activities and project. For a project where on-time completion is critical the principal may require a hard date for completion, without any right for the contractor to claim an extension to the completion date. The trade-off might be that the contractor receives a larger incentive than would otherwise be the case.
In conclusion, Liquidated Damages and Bonus or Incentive scheme are complimentary approaches to ensuring that Early Work is not delayed in a critical time dependent project, and fund is not lost, and quality of data is maintained. It should not be accepted as a clause to forestall the breach of the entire contract terms or impose a penalty on the contractor.
Prof. Goodwill Ofunne, Ph.D.
Managing Director, Fundamental Integrated Site Appraisal Services Limited, Gudu District, Abuja