For the last several years, the Texas Residential Construction Commission ("TRCC") has been the topic of plenty of commentary and opinions (both positive and negative) in the residential construction industry. But all that discussion may become moot in the near future.
The legislation that created the TRCC also stated that, unless continued through further legislation, the TRCC would automatically be abolished as of September 1, 2009. As a result, the Texas Sunset Advisory Commission (an agency created to identify and eliminate waste, duplication, and inefficiency in government) reviewed the TRCC to determine whether it should be continued.
In January 2009, the Sunset Commission issued its report and recommended that the Texas Residential Construction Commission be abolished and the Texas Residential Construction Commission Act be repealed. According to the report, the TRCC was never completely effective at any of its purposes.
During the current legislative session, State Representative Todd Smith of Tarrant County proposed legislation that took the demise of the TRCC a step further. On February 23, 2009, Representative Smith introduced HB 1635, a bill that would abolish the Texas Residential Construction Commission as of February 10, 2010 (if enacted). You can see the bill, as introduced, here.
This legislation would also exempt from liability a builder hired by a lender to complete the construction of a foreclosed home. This exemption would apply to construction defects of which the builder had no knowledge that existed prior to the acquisition of the home by the lender. The builder would, however, still be liable for work performed for the lender after the acquisition of the home by the lender.
Of course, HB1635 is in its infancy and it remains to be seen what, if any changes are made, whether it will gain enough votes to pass, and whether the governor will sign it into law. It also remains to be seen if another representative or senator will propose legislation that would attempt to continue the existence of the TRCC. In any event, this is definitely something to watch, as the fate of the Texas Residential Construction Commission will have a significant impact on everyone in the residential construction industry.
Monday, March 2, 2009
Tuesday, February 24, 2009
Construction Contingent Payment Act–The Legislature’s Modifications to the Rules of the Game
Contingent payment clauses (also known as "pay when paid" or "pay if paid" clauses) have long been a tool used by contractors to shift the risk of nonpayment. In short, the payor's payment to the payee is contingent on the payor itself being paid by another party (usually the owner). Under these clauses, if the payor is not paid, it has no obligation to make payments to the payees (subcontractors). These clauses effectively shift the risk of nonpayment from the general contractor to the subcontractor (or from subcontractor to sub-subcontractor).
For more on crafting enforceable contingent payment clauses, see my previous blog article.
In 2007, the Texas Legislature stepped in and placed some additional rules on these clauses through Section 35.521 of the Texas Business & Commerce Code (you can read about the Legislature’s labor here, or you can just see the "baby" here--to borrow a line from Bill Parcels). In a nutshell, the Act established certain situations where a contingent pay clause cannot be used as a defense for not paying subcontractors. A payor may NOT avoid payment in the following situations:
For more on crafting enforceable contingent payment clauses, see my previous blog article.
In 2007, the Texas Legislature stepped in and placed some additional rules on these clauses through Section 35.521 of the Texas Business & Commerce Code (you can read about the Legislature’s labor here, or you can just see the "baby" here--to borrow a line from Bill Parcels). In a nutshell, the Act established certain situations where a contingent pay clause cannot be used as a defense for not paying subcontractors. A payor may NOT avoid payment in the following situations:
- When the owner’s nonpayment to the GC is the result of the GC not meeting its own obligations, unless the non payment is the result of the subcontractor’s failure to meet its requirements.
- When the owner fails to pay the GC because of the work of another subcontractor, the contingent pay clause is not effective as to the innocent subcontractor.
- When, after a subcontractor has not been paid for past work, it gives notice to the GC objecting to the further enforceability of the contingent pay clause, the GC may not then enforce the clause on work or materials provided after the notice.
- When the owner and GC are essentially the same.
- When enforcement of the clause would be "unconscionable."
- A contingent pay clause may not be used as a basis for invalidation of the enforceability or perfection of an otherwise valid lien.
The requirements of the Act cannot be waived. However, the Act does allow for the assertion of a contingent pay clause as an affirmative defense to a lawsuit for payment under a contract. Finally, the Act does not apply to design services, civil engineering construction (roads, utilities, water supply projects, etc.), and most residential construction.
What is the lesson to be learned from this statute? First, good faith is generally required on the part of the general contractor to avoid one of the exceptions to enforceability of an otherwise valid contingent pay clause. Second, it is evidence that the Legislature has made increased efforts to protect subcontractors from heavy handed contractual provisions. A contingent pay bill was first introduced (unsuccessfully) in the 2003 Legislative session. Four years later, in 2007, the current version was passed. It will be interesting to see if this year’s legislative session results in any new measures.
Monday, February 16, 2009
Personal Liability Under the Texas Construction Trust Fund Act: The 800 Pound Gorilla You Never Knew Existed
Most people in the construction industry have at least some awareness of the Texas Construction Trust Fund Act. For an overview of the Act, I recommend my blog article here.
What many contractors may not realize is the potential personal liability that the Trust Fund Act creates. It is very important to be aware of this fact in advance to avoid potentially serious mistakes down the road.
In a nutshell, the Act deems construction payments and loan receipts "trust funds." The corollary is that a "contractor, subcontractor, or owner or an officer, director, or agent of a contractor, subcontractor, or owner, who receives trust funds or who has control or direction of trust funds, is a trustee of the trust funds." What does that mean? It means that the individual owner, officer, director, or agent may personally be a trustee. Trustee status does not simply stop at the corporate veil.
If an individual is a trustee, he or she owes the beneficiary of the trust funds a fiduciary duty. This means a duty of loyalty, and the utmost good faith, candor, integrity of the highest kind, and fair and honest dealing. The fiduciary duty is basically the highest standard of care in our legal system.
Because the Act confers "trustee status" on individuals and not just companies, personal liability can also fall to the individual–even if they were acting solely in the course and scope of their employment and in furtherance of their employer’s business.
In Herbert v. Greater Gulf Coast Enterprises, Inc., 915 S.W.2d 866 (Tex.App.–Houston [1st Dist.] 1995), the Houston Court of Appeals found personal jurisdiction for Trust Fund Act violations over someone who had no individual contact with Texas. In that case, the plaintiff, a subcontractor, sued the Connecticut general contractor and its president individually. The court rejected the defendant’s argument that he individually had no contact with Texas. In its ruling, the court noted that the Legislature enacted the Construction Trust Fund Act as a special protection for contractors and subcontractors "to avoid the injustice of owners and contractors refusal to pay for work completed."
The plaintiff in Kelly v. General Interior Construction, 262 S.W.3d 79 (Tex.App.–Houston [14th Dist.] July 3, 2008) sued the two sole shareholders of an Arizona GC individually for breach of contract, violations of the Construction Trust Fund Act, and fraud. The defendants argued that Texas courts did not have personal jurisdiction over them individually because they acted solely in their corporate capacity. The court ruled that there was no jurisdiction on the breach of contract claim because the individuals had, in fact, acted on behalf of their company. However, they found jurisdiction on the Trust Fund Act claim. The court noted that the Trust Fund Act essentially allows subcontractors to pierce the corporate veil. The Act creates personal liability if (1) the party breaches the Act’s duties with the appropriate intent, and (2) the claimants are within the class of people the Act was designed to protect.
C&G, Inc. d/b/a Fox Rental v. Jones, 165 S.W.3d 450 (Tex.App.–Dallas 2005) is a very interesting case (particularly if you want to give yourself a little heartburn). Fox Rental sued CCG supply company, including officers Jones and Duncan under Trust Fund Act. Jones and Duncan had signatory authority on CCG's checking account. Neither of them personally received any trust funds, nor did they "independently" determine to whom the trust funds should be paid. In fact, they simply disbursed such funds as they were directed by the officers of American Eco, which owned CCG. Over time, Jones and Duncan objected to American Eco’s use and direction of the funds; in fact, they were eventually asked to leave their employment in large part because of their objections to the way American Eco handled the funds. By all accounts, these guys were doing the "right thing" and objecting.
Nevertheless, court of appeals held that they participated in both the decision to divert the funds and the actual diversion of the funds. As such, they were held personally liable. Their objections were not a defense, and the court did not accept the "just following instructions" justification either.
The point of this discussion is that construction trust funds are a serious matter that can bring serious personal liability. There are defenses to claims of violations of the Act, but with the potential for personal liability, these defenses should be particularly well documented. In any event, construction trust funds are not something to play fast and loose with. Knowing the Act’s requirements and potential for liability in advance will, however, help minimize liability down the road.
What many contractors may not realize is the potential personal liability that the Trust Fund Act creates. It is very important to be aware of this fact in advance to avoid potentially serious mistakes down the road.
In a nutshell, the Act deems construction payments and loan receipts "trust funds." The corollary is that a "contractor, subcontractor, or owner or an officer, director, or agent of a contractor, subcontractor, or owner, who receives trust funds or who has control or direction of trust funds, is a trustee of the trust funds." What does that mean? It means that the individual owner, officer, director, or agent may personally be a trustee. Trustee status does not simply stop at the corporate veil.
If an individual is a trustee, he or she owes the beneficiary of the trust funds a fiduciary duty. This means a duty of loyalty, and the utmost good faith, candor, integrity of the highest kind, and fair and honest dealing. The fiduciary duty is basically the highest standard of care in our legal system.
Because the Act confers "trustee status" on individuals and not just companies, personal liability can also fall to the individual–even if they were acting solely in the course and scope of their employment and in furtherance of their employer’s business.
In Herbert v. Greater Gulf Coast Enterprises, Inc., 915 S.W.2d 866 (Tex.App.–Houston [1st Dist.] 1995), the Houston Court of Appeals found personal jurisdiction for Trust Fund Act violations over someone who had no individual contact with Texas. In that case, the plaintiff, a subcontractor, sued the Connecticut general contractor and its president individually. The court rejected the defendant’s argument that he individually had no contact with Texas. In its ruling, the court noted that the Legislature enacted the Construction Trust Fund Act as a special protection for contractors and subcontractors "to avoid the injustice of owners and contractors refusal to pay for work completed."
The plaintiff in Kelly v. General Interior Construction, 262 S.W.3d 79 (Tex.App.–Houston [14th Dist.] July 3, 2008) sued the two sole shareholders of an Arizona GC individually for breach of contract, violations of the Construction Trust Fund Act, and fraud. The defendants argued that Texas courts did not have personal jurisdiction over them individually because they acted solely in their corporate capacity. The court ruled that there was no jurisdiction on the breach of contract claim because the individuals had, in fact, acted on behalf of their company. However, they found jurisdiction on the Trust Fund Act claim. The court noted that the Trust Fund Act essentially allows subcontractors to pierce the corporate veil. The Act creates personal liability if (1) the party breaches the Act’s duties with the appropriate intent, and (2) the claimants are within the class of people the Act was designed to protect.
C&G, Inc. d/b/a Fox Rental v. Jones, 165 S.W.3d 450 (Tex.App.–Dallas 2005) is a very interesting case (particularly if you want to give yourself a little heartburn). Fox Rental sued CCG supply company, including officers Jones and Duncan under Trust Fund Act. Jones and Duncan had signatory authority on CCG's checking account. Neither of them personally received any trust funds, nor did they "independently" determine to whom the trust funds should be paid. In fact, they simply disbursed such funds as they were directed by the officers of American Eco, which owned CCG. Over time, Jones and Duncan objected to American Eco’s use and direction of the funds; in fact, they were eventually asked to leave their employment in large part because of their objections to the way American Eco handled the funds. By all accounts, these guys were doing the "right thing" and objecting.
Nevertheless, court of appeals held that they participated in both the decision to divert the funds and the actual diversion of the funds. As such, they were held personally liable. Their objections were not a defense, and the court did not accept the "just following instructions" justification either.
The point of this discussion is that construction trust funds are a serious matter that can bring serious personal liability. There are defenses to claims of violations of the Act, but with the potential for personal liability, these defenses should be particularly well documented. In any event, construction trust funds are not something to play fast and loose with. Knowing the Act’s requirements and potential for liability in advance will, however, help minimize liability down the road.
Wednesday, January 21, 2009
Construction Law CLE on Texas Payment Statutes
A little self-promotion from the Texas Construction Law Blogger:
On Thursday, February 5th at 12:00 noon, Walker M. Duke will be presenting the Continuing Legal Education program "Three Payment Statutes Every Construction Lawyer Should Know" to the Construction Law Section of the Dallas Bar Association at the Belo Mansion, 2101 Ross Avenue, Dallas, Texas.
The presentation will discuss three statutes that relate to payment issues in the construction industry. First is the Texas Prompt Payment to Contractors and Subcontractors Act. This Act is useful for attorneys to know because it provides some guidance to a common scenario—a subcontractor has not been paid on a job and does not know whether to walk off the job for nonpayment or continue and hope for the best.
The second statute is the Texas Construction Trust Fund Act. This statute covers how construction funds and loan receipts should be handled. Construction law attorneys should be aware of the requirements of this statute because failure to meet its requirements can result in criminal penalties, in addition to civil liability.
The third topic is Texas lien laws. Liens can be a powerful tool for builders and contractors to encourage payment for services rendered and goods provided. However, they are fairly technical and must meet the strict requirements of the Texas Property Code. Failure to comply with these requirements, including deadlines (that are often blown by contractors before they call their lawyer), prevents proper perfection of the lien, and could result in a sizeable liability for wrongfully filing a lien.
For more information, contact Walker Duke at (214) 891-8040 or the Dallas Bar Association at (214) 220-7400.
On Thursday, February 5th at 12:00 noon, Walker M. Duke will be presenting the Continuing Legal Education program "Three Payment Statutes Every Construction Lawyer Should Know" to the Construction Law Section of the Dallas Bar Association at the Belo Mansion, 2101 Ross Avenue, Dallas, Texas.
The presentation will discuss three statutes that relate to payment issues in the construction industry. First is the Texas Prompt Payment to Contractors and Subcontractors Act. This Act is useful for attorneys to know because it provides some guidance to a common scenario—a subcontractor has not been paid on a job and does not know whether to walk off the job for nonpayment or continue and hope for the best.
The second statute is the Texas Construction Trust Fund Act. This statute covers how construction funds and loan receipts should be handled. Construction law attorneys should be aware of the requirements of this statute because failure to meet its requirements can result in criminal penalties, in addition to civil liability.
The third topic is Texas lien laws. Liens can be a powerful tool for builders and contractors to encourage payment for services rendered and goods provided. However, they are fairly technical and must meet the strict requirements of the Texas Property Code. Failure to comply with these requirements, including deadlines (that are often blown by contractors before they call their lawyer), prevents proper perfection of the lien, and could result in a sizeable liability for wrongfully filing a lien.
For more information, contact Walker Duke at (214) 891-8040 or the Dallas Bar Association at (214) 220-7400.
Wednesday, November 26, 2008
Green Tax Relief
The Energy Policy Act of 2005 (26 U.S.C. § 179D) created a tax incentive to improve energy efficiency of commercial buildings (this tax incentive was extended through 2013 as part of the Emergency Economic Stabilization Act of 2008, a/k/a "The Banking Bailout"). The "Commercial Building Tax Deduction" established a tax deduction for expenses incurred for energy efficient building expenditures made by the building owner. The deduction is equal to energy-efficient commercial building expenditures made by the taxpayer, subject to a cap of $1.80 per square foot.
The tax credit applies to "energy efficient commercial building property." But what exactly does that term mean? It means property–
1) for which depreciation is allowable;
2) installed on or in any building in the US and within the scope of ASHRAE Standard 90.1-2001;
3) which is installed as part of the interior lighting systems; the heating, cooling, ventilation, and hot water systems; or the building envelope; and
4) which is certified as being installed as part of a plan designed to reduce the total annual energy and power costs with respect to the aforementioned building systems by 50% or more (in comparison to a reference building which meets the minimum requirements of ASHRAE .Standard 90.1-2001.
Certification requirements must be met to qualify for these deductions. The secretary of the treasury, in consultation with the secretary of the secretary of energy, provided guidance in Notice 2006-52 that describes methods of calculating and verifying energy and power costs, using qualified computer software based on provisions of the 2005 California Nonresidential Alternative Calculation Method Approval Manual and the 2005 California Residential Alternative Method Approval Manual. Inspections must be performed by engineers or licensed contractors, and they must meet the guidelines of the National Renewable Energy Laboratory.
Partial deductions are available for buildings that do not meet the whole building requirement of 50% energy savings. The deduction is allowed with respect to each separate building system that comprises the energy-efficient property. For these "component deductions," the requirements are as follows: 20% savings for interior lighting, 20% savings for HVAC and hot water, and 10% savings for building envelope. The maximum allowable deduction for the separate systems is $.60 per square foot.
Other notable features about the Commercial Building Tax Deduction:
The tax credit applies to "energy efficient commercial building property." But what exactly does that term mean? It means property–
1) for which depreciation is allowable;
2) installed on or in any building in the US and within the scope of ASHRAE Standard 90.1-2001;
3) which is installed as part of the interior lighting systems; the heating, cooling, ventilation, and hot water systems; or the building envelope; and
4) which is certified as being installed as part of a plan designed to reduce the total annual energy and power costs with respect to the aforementioned building systems by 50% or more (in comparison to a reference building which meets the minimum requirements of ASHRAE .Standard 90.1-2001.
Certification requirements must be met to qualify for these deductions. The secretary of the treasury, in consultation with the secretary of the secretary of energy, provided guidance in Notice 2006-52 that describes methods of calculating and verifying energy and power costs, using qualified computer software based on provisions of the 2005 California Nonresidential Alternative Calculation Method Approval Manual and the 2005 California Residential Alternative Method Approval Manual. Inspections must be performed by engineers or licensed contractors, and they must meet the guidelines of the National Renewable Energy Laboratory.
Partial deductions are available for buildings that do not meet the whole building requirement of 50% energy savings. The deduction is allowed with respect to each separate building system that comprises the energy-efficient property. For these "component deductions," the requirements are as follows: 20% savings for interior lighting, 20% savings for HVAC and hot water, and 10% savings for building envelope. The maximum allowable deduction for the separate systems is $.60 per square foot.
Other notable features about the Commercial Building Tax Deduction:
- Churches are not eligible for the deduction.
- Portions of buildings (e.g. common areas, portions of common areas, etc.) can be retrofitted and the associated square footage considered for the deduction.
- Screw-in compact fluorescent lamps (CFLs) cannot be used to reduce wattage for purposes of the deduction. ASHRAE 90.1-2001 lighting power calculations require maximum labeled wattage of incandescent luminaire be used.
Anyone who has even considered designing or constructing a "green" building knows that the associated costs are much higher than a traditional build. However, the Commercial Building Tax Deduction at least mitigates some of that cost and makes it a little easier to be green.
Friday, November 21, 2008
LEED To Be Upgraded in 2009
In 2000, the US Green Building Council (USGBC) introduced the LEED Green Building Rating System. For the last 8 years, the LEED system has established a set of integrated, measurable goals that guided how eco-conscious buildings were to be designed and constructed.
LEED v3, which will go into effect in 2009, will bring about several significant changes to the green building rating system, and it will have several components. The updated technical standards will be codified in LEED 2009. This was not intended to be a "tear down and rebuilt" of the current LEED system, but rather, a reorganization of the existing system. The USGBC has characterized LEED 2009 as the sum of four parts:
1. LEED prerequisite/credit alignment and harmonization
2. Predictable development cycle
3. Transparent environmental/human impact credit weighting
4. Regionalization
The second part of LEED v3 is an expanded third-party certification program. Currently, all LEED project submissions are reviewed by USGBC with the support of independently contracted reviewers. Beginning in January 2009, however, the USGBC will move administration of the LEED certification process to the Green Building Certification Institute, a non-profit organization established in 2007. This reorganization was done to improve the overall certification process in way that can grow with the demand for green building certification. The other goal was to establish third-party certification that can be audited to determine effectiveness and fairness.
The third part of LEED v3 is the LEED Online management system, which should hopefully make the legwork part of all-things-LEED a little easier.
With 8 years of growing pains out of the way, and over 7,000 comments on LEED 2009, hopefully the USGBC has developed a good sense of what works and what doesn’t. All in all, LEED v3 should be an enhanced, more workable version of what was started in 2000.
LEED v3, which will go into effect in 2009, will bring about several significant changes to the green building rating system, and it will have several components. The updated technical standards will be codified in LEED 2009. This was not intended to be a "tear down and rebuilt" of the current LEED system, but rather, a reorganization of the existing system. The USGBC has characterized LEED 2009 as the sum of four parts:
1. LEED prerequisite/credit alignment and harmonization
2. Predictable development cycle
3. Transparent environmental/human impact credit weighting
4. Regionalization
The second part of LEED v3 is an expanded third-party certification program. Currently, all LEED project submissions are reviewed by USGBC with the support of independently contracted reviewers. Beginning in January 2009, however, the USGBC will move administration of the LEED certification process to the Green Building Certification Institute, a non-profit organization established in 2007. This reorganization was done to improve the overall certification process in way that can grow with the demand for green building certification. The other goal was to establish third-party certification that can be audited to determine effectiveness and fairness.
The third part of LEED v3 is the LEED Online management system, which should hopefully make the legwork part of all-things-LEED a little easier.
With 8 years of growing pains out of the way, and over 7,000 comments on LEED 2009, hopefully the USGBC has developed a good sense of what works and what doesn’t. All in all, LEED v3 should be an enhanced, more workable version of what was started in 2000.
Monday, November 3, 2008
Liquidated Damages: Be Sure You Get What You Bargained For
At some point in the life of every construction business, a project will not go as planned. For whatever reason, the project just does not unfold as it was originally designed. Maybe it was because another contractor had to repair its own mistake, maybe it was bad weather, or maybe the work was just slower than what was initially estimated. Despite best efforts, the original schedules become a thing of distant memory.
Anyone who has been in this situation knows that it does not take long before the finger pointing begins, which is quickly followed by damage claims related to the delays. However, delay damages can be very difficult to quantify and calculate. Some elements may be fairly concrete, such as rents lost due to a building opening 90 days late. Other elements are more nebulous, like the value of the extra time office employees spent working on the project (extended home office overhead), lost opportunities of other projects, etc.
One solution to some of the uncertainty of delay damages is the inclusion of a liquidated damages clause in the construction contract. In a nutshell, liquidated damages clauses provide that the non-breaching party is entitled to a certain amount of damages if specified conditions are not met. Probably the most common example is a provision that awards one party a certain dollar figure per day a project is late in completion.
Like so many other provisions, liquidated damages clauses are deal points that are negotiated. If you worked to get a liquidated damage clause included in your contract, you certainly want to be sure it is enforceable.
To be valid, a liquidated damages clause must satisfy a two-part test. First, the damages covered by the clause should be incapable or difficult to estimate at the time of the contracting. Second, the liquidated amount must be a reasonable calculation of expected damages. The key is that a liquidated damages clause must not be a penalty. For example, a provision that provides $5,000 per day that a project is late, when the actual amount of damages relating to the delay is closer to $500, is likely to be struck down. The clause does not provide a reasonable substitute for actual damages but rather, it acts as a penalty.
A liquidated damages clause that is considered a penalty is not enforceable. In other words, that heavy handed damages clause that you traded some deal points to have included in the contract may be worthless.
These clauses can be particularly powerful when used in combination with a provision that specifically states that liquidated damages are the exclusive remedy available for breach of the contract. This essentially eliminates the possibility of recovering consequential damages. From the owner’s perspective, this could create a higher per day amount. From the contractor’s perspective, it provides some limitation on potential liability.
In any event, liquidated damages clauses should be as specific as possible to prevent confusion down the road. If damages are to accrue on workdays only, language to that effect should be included. Conversely, if weekends and holidays are to be included in the damage calculation, that should be explicitly stated. Ambiguity can cost you. Considering the fact that there are around 100 weekend days in a year, not to mention holidays, a twelve month delay could potentially increase (or decrease) damages by almost a third.
Liquidated damages clauses are an effective way to remove some of the uncertainty related to construction delay claims. The specific details are negotiable, but they need to be a reasonable estimate of difficult-to-calculate damages. Should the dispute go to litigation, these clauses can lower expenses incurred in determining the exact amount of damages related to the delay. However, these clauses may also be the sole remedy should a construction project go bad. The specifics of each contract will determine whether a liquidated damages provision is appropriate, but it is always a good item to have in your negotiation toolbox.
Anyone who has been in this situation knows that it does not take long before the finger pointing begins, which is quickly followed by damage claims related to the delays. However, delay damages can be very difficult to quantify and calculate. Some elements may be fairly concrete, such as rents lost due to a building opening 90 days late. Other elements are more nebulous, like the value of the extra time office employees spent working on the project (extended home office overhead), lost opportunities of other projects, etc.
One solution to some of the uncertainty of delay damages is the inclusion of a liquidated damages clause in the construction contract. In a nutshell, liquidated damages clauses provide that the non-breaching party is entitled to a certain amount of damages if specified conditions are not met. Probably the most common example is a provision that awards one party a certain dollar figure per day a project is late in completion.
Like so many other provisions, liquidated damages clauses are deal points that are negotiated. If you worked to get a liquidated damage clause included in your contract, you certainly want to be sure it is enforceable.
To be valid, a liquidated damages clause must satisfy a two-part test. First, the damages covered by the clause should be incapable or difficult to estimate at the time of the contracting. Second, the liquidated amount must be a reasonable calculation of expected damages. The key is that a liquidated damages clause must not be a penalty. For example, a provision that provides $5,000 per day that a project is late, when the actual amount of damages relating to the delay is closer to $500, is likely to be struck down. The clause does not provide a reasonable substitute for actual damages but rather, it acts as a penalty.
A liquidated damages clause that is considered a penalty is not enforceable. In other words, that heavy handed damages clause that you traded some deal points to have included in the contract may be worthless.
These clauses can be particularly powerful when used in combination with a provision that specifically states that liquidated damages are the exclusive remedy available for breach of the contract. This essentially eliminates the possibility of recovering consequential damages. From the owner’s perspective, this could create a higher per day amount. From the contractor’s perspective, it provides some limitation on potential liability.
In any event, liquidated damages clauses should be as specific as possible to prevent confusion down the road. If damages are to accrue on workdays only, language to that effect should be included. Conversely, if weekends and holidays are to be included in the damage calculation, that should be explicitly stated. Ambiguity can cost you. Considering the fact that there are around 100 weekend days in a year, not to mention holidays, a twelve month delay could potentially increase (or decrease) damages by almost a third.
Liquidated damages clauses are an effective way to remove some of the uncertainty related to construction delay claims. The specific details are negotiable, but they need to be a reasonable estimate of difficult-to-calculate damages. Should the dispute go to litigation, these clauses can lower expenses incurred in determining the exact amount of damages related to the delay. However, these clauses may also be the sole remedy should a construction project go bad. The specifics of each contract will determine whether a liquidated damages provision is appropriate, but it is always a good item to have in your negotiation toolbox.
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