Damages for delay: what is fair?

Few people pay for construction work unless they intend to put the end product to use, either as their own residences or for a business or public purpose. In any case, there are repercussions — with dollars attached — if the end users can't get access when they planned. Yet more often than not, the subject of damages for delayed completion isn't adequately discussed (if it is discussed at all) at the time the customer and contractor are entering their agreement.

This is an area where the law will fill in the blanks for the parties if they don't deal with it contractually, so it makes sense to think the issue over and see if you can come to an agreement that you believe will be fair to both sides.

What if there is nothing in the contract? It doesn't mean that the contractor has no liability for being late. As mentioned above, most construction contracts don't address the subject of damages for delay in completion, in which case the "common law" will generally apply. This would allow the customer to recover its foreseeable expenses and lost profits as a result of being deprived of the space. Some of the kinds of damages a typical customer might have are hold-over rent at the old space, or short-term rent, at a much higher rental rate; storage charges for furnishings; cancellation charges or non-refundable expenses associated with the move; and extra architect, engineer and owner's representative expenses. This may or may not be in line with the parties' expectations, and if they want something more, they should address it in writing, and up front, when they negotiate a contract.

What about "liquidated damages?" Many contracts, including most contracts for public owners, contain a provision where the parties agree that, instead of paying for the actual out-of-pocket costs caused by their delays, contractors will pay a stipulated generally daily rate known as "liquidated" damages. If done right, this should approximate the actual likely expenses associated with late completion, and allows the contractor to manage its risk by knowing in advance what the worst case will be if it is late in completion.

But it is not always so easy to get it right. If the rate is too low, the contractor may find it is cheaper to let the job drag on than pay overtime to speed it up. If the rate is too high, it might end up not being enforceable. Also, courts tend to cut public owners a lot of slack over their daily rates for projects with little actual delay damages but a ton of public inconvenience (i.e., a shut down interstate) or potential policy issues (delayed weapon system or cancer research center). There is no reason private parties can't use liquidated damages too, though, and many are going this route.

Do these damages get passed through to subcontractors? Does a duck quack? Of course general contractors and upper-tier subs would like to pass them on, but they don't always get it right. For example, they often write contracts, which allow them to pass on to subs damages assessed against them and forget to include any damages that they themselves might also be incurring because of a delay. Sometimes they forget to mention that the damages have been liquidated by agreement and a court won't force them on to a sub that knew nothing about them. Also, if more than one sub was involved in a delay, or accused of delaying the job, it will be much tougher for the general contractor to come up with the right allocation among multiple parties.

Is there exposure to more than just out-of-pocket expenses? Does a duck swim? Unless the parties have agreed to waive the right to seek "consequential" damages, an owner can sue for its lost profits too — subject to proving that they were "foreseeable." Lost revenue from a scheduled NFL game or a casino operation can be a huge number. Any party signing on to such a contract should give a lot of thought to what risk is worth running and at what point to walk away. (If the job is bonded, you can count on the surety to specifically look at this!)

Who decides when the delay damages start and stop? Typically, the contracts will say that the damages start, and typically, that will be the date of promised substantial completion, when the owner could use the work for its intended purpose, and they should stop when the work could be used — whether the owner chooses to put it in operation or not, and whether an architect or engineer has blessed it or not. However, this is also something that can be varied from contract to contract.

With margins on work at an all-time low, contractors have to be wise in choosing how much risk to run. Thinking through and negotiating the most appropriate terms for your project can save you some sleepless nights.

Susan McGreevy is a partner at Stinson, Morrison, Hecker LLP, Kansas City, Mo., 816/842-4800, e-mail to [email protected].