What are liquidated damages?
Liquidated damages are financial penalties that are levied upon the contractor based upon contractual failures. In most cases, the penalties apply to failure to properly accomplish and meet construction scheduling dates, which are established within the construction schedule for the project.
What is the majority of contractor’s initial reaction?
In most situations, the contractor is immediately against the establishment of liquidated damages in the contract. The contractor will initially react in a very negative fashion, citing issues such as lack of trust, deterioration of the team approach to a successful project, etc. Unless the contractor is an accomplished negotiator and experienced in the art of the construction contract, there will be negative response.
Here’s another way to address the issue.
I recommend another avenue of negotiation and thought processing, when it comes to liquidated damages on the contractor’s side. This opinion is based upon many years of managing very difficult and complicated liquidated damage claims and construction projects, which have been mismanaged by contractors who find themselves in a liquidated damage claim against them.
The contractor should proceed as follows, when confronted by a client that insists on a construction contract with a liquidated damage clause.
1.) Reluctantly accept the liquidated damage clause. The owner, architect or developer on the other side of the contract will expect the contractor to resist a liquidated clause. Do not disappoint them! It is important that you, as the contractor, clearly identify your reluctance and disappointment regarding the insistence of a liquidated clause.
2.) By reluctantly accepting the liquidated damage clause in the contract, you as the contractor have now associated a level of mistrust and a lack of team play into the equation based upon this liquidated damage insistence. However, both of these theoretical negative characteristics for this contract agreement will provide a healthier environment for the contractor to stimulate more financial opportunity. Remember, you are there for one reason, to make money!
3.) It is my opinion that, if the owner, architect or developer introduces a liquidated damage clause into the contract, they are insinuating a more negative environment into the management of the project. Why introduce a liquidated damage clause, if you feel that the contractor, as a team member will play according to all of the rules, and perform the work in the best manner possible for the benefit of the entire project. If that were the case, the owner, architect or developer would not be interested in a liquidated damage clause.
4.) Once the negotiations have resulted in the insistence on a liquidated damage clause, the contractor should push back with the insistence on a positive incentive clause. If the architect, owner or developer is insisting on the negative liquidated damage clause, then it makes sense that the contractor should insist on a positive incentive clause.
What is a positive incentive clause?
A positive incentive clause can take many different forms. There can be a reward type clause that rewards the contractor, if the project is completed prior to the formal completion date, if the budget is reduced, or if cost saving incentives is suggested and implemented. There are different types of positive incentives that can be included within the construction contract. The important aspect of this concept is the tradeoff of liquidated clause with a positive incentive clause. The reason that the contractor should look at the liquidated damage clause, when presented by the opposite party, as an opportunity is the positive incentive clause. Turn the entire concept for the project around; if the architect, owner and developer feels inclined to insist on the liquidated clause, then the contractor should take this opportunity to insist on the positive incentive clause.
Contractor’s recommended management techniques once a liquidated damage clause is included within the contract.
1.) As I have repeatedly insisted upon, throughout this website, the need for proper documentation of all issues on the project is mandatory, especially if there is a liquidated damage clause in the contract. Document, document and more documentation. What needs to be specifically identified?
a.) RFI’s are a sacred piece of documentation. Each Request for Information must be carefully and accurately identified with the reason for the question, the date, as well as a full and complete documentation of the timing of any responses.
b.) RFI’s must include the time that an answer must be received. Each RFI must clearly and accurately indicate what type of effect the question has on the project. If the question holds up the submission of the reinforcing documents, if the RFI delays the layout of any of the actual construction, each situation MUST be clearly identified.
c.) Change Orders are as important as the RFI’s in a project that has a liquidated damage claim. Each change order must be clearly developed to enable future understanding of the effects of the change order on the schedule as well as the budget of the project. A precise and accurate management system of Change Orders is imperative to the success of the project, especially if there are liquidated damages.
d.) Daily reports. The importance of your superintendent’s daily reports is extremely important to the proper management of the liquidated clause. Each daily report must properly account for each RFI and Change Order that has been issued and the effect of each of these documents on the project. The superintendent must be cognizant of the importance of clearly and accurately reporting every daily issue.
2.) It is extremely important that all team players, on the contractors side, understand the importance of communication and documentation regarding the insistence of a liquidated damage clause in the contract. I recommend that this becomes a game, that the players on the contractor’s side become intimately involved in. I have been extremely open, when it comes to the defensive side of a contract that has liquidated damages in it. I do not hesitate to indicate that the insistence of a liquidated clause could indicate a negative opinion as well as a lack of confidence on the owner’s behalf. I have used this negative incentive to stimulate the energy required to properly and confidently manage the communications required, to properly defend against any liquidated damage claim that the architect, owner of developer might consider.
3.) It is imperative that all management personnel on the contractor’s side of the agreement understand the importance of defending the liquidated damage claims. Each position, from the project manager to the assistant field superintendent and engineer must understand that any item that could be considered a delay, or additional cost, be clearly documented. Overdue it! Each individual must understand the importance, as well as the opportunities that the inclusion of a liquidated damage clause could have on the final completion of the project. Once there is a liquidated damage clause, the so-called gloves must be off.
4.) What are some particular field issues that could evolve into substantial supportive information, defending any claims of liquidated damages?
a.) Shop drawing and submittal scheduling. If the shop documents or the formal submittals are not returned or acted upon in accordance with the contract documents, document it! No matter how incidental or non-consequential to the overall outcome of the project, document it. Any delay is a delay!
b.) Failure of the contract documents to provide every dimension and detail necessary to properly, and in a timely fashion, construct the project, must be documented. It does not matter if the color of the walls is the issue, document it.
c.) As previously noted, every RFI, Change Order, or other type of consequence that provides an opportunity to identify failure on the architect or owner’s part, document the occurrence. Do not be shy! This is a matter of financial success, you did not start the game with the insistence of liquidated damages!
d.) Any owner ordered material, equipment or subcontractor requirement, which is identified as the owners, the developers or another parties, responsibility, document it. Any delay, no matter how small, or currently non consequential must be clearly defined. Although it is repetitious, the continually management and documentation of every element of delay, indecision, incorrect data or simply stupid misdirection must be documented!!
e.) Include the liquidated damage clause in every subcontractor contract and include every subcontractor in the assault on the owner, architect or developer who has insisted on this liquidated damage clause. Do not allow any subcontractor to be off the hook, if the liquidated damage clause is your responsibility, it is also the responsibility of every subcontractor.
The opportunity to use a contract with liquidated damages in a fashion that will ultimately make you money is extremely important and exciting. If the architect, owner or developer feels it necessary to incorporate a liquidated damage clause, use it as a stimulus for an aggressive and relentless assault on the accuracy of the architect’s documents, the owner’s financial capabilities, as well as the developer’s ability to achieve the proper permits and approvals.
I personally enjoy being involved with a contract that has liquidated damages included. What this immediately indicates to me is the following;
1.) The owner, architect and developer, even if identified differently, are NOT team players.
2.) The parties on the other side of the contract are the opponent, and not a team member.
3.) The liquidated damage clause in the contract can be used as a stimulus to your team of players, that you are not trusted, and certainly not considered, trying your best, if there is a liquidated damage clause included.
4.) The liquidated damage clause can be used as an incentive for bonuses and appreciation by the contractor when dealing with their employees.
5.) Use the liquidated damage clause, as a focal point for additional professional management and communication. Insist on proper daily reports, as well as subcontractor daily reports.
6.) Insist that the liquidated damage clause be used by your own personnel to instill a sense of teamwork focused on a common theme. No liquidated damage only focused and detailed positive change orders to the owner and architect.
7.) Use the liquidated clause as a reason to charge for everything! It is amazing how much is actually given away to an owner, architect or developer. Each subcontractor will attempt to be the best friend of the owner, architect or developer. Stop this immediately by clearly identifying the insistence on the liquidated damage clause. Use this clause as incentive for the subs to never give it away!
8.) Use the attitude that if you can give it away, your price was too high to start with! If there is a liquidated damages clause in the contract, every price, every estimate, every change order is accurate and without any slush fund, additional money, or padding, whatever financial description that you want to use.
9.) Liquidated damages equals no holds barred management and supervision.
In summary, the inclusion of a liquidated damages clause in a construction contract is a clear and very obvious identification of where you, as the contractor, stand in the opinion of the owner, architect or developer. It is a perfect sign of exposure for the opposite side, and should be managed with this in mind. Do not allow the opposition to take advantage of that liquidated clause. Take the position, that if they are so perfect, that they can place a liquidated damage claim on us, then we will never look the other way, allow the benefit of the doubt, or assist with any of the design situations that will always occur on every construction project.
On the contractors side / the insistence on liquidated damages has just changed the game from flag to tackle! Enjoy the contact!