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PROCUREMENT PERSPECTIVES - Tackling the liquidated damages issue

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by Stephen Bauld last update:Sep 10, 2014

Procurement Perspectives - Liquidated damages are an issue every contractor must deal with during the contract. A major aspect to be considered with respect to construction industry contract structure is the factor of the timing of the various supply agreements involved in the construction of an improvement.
PROCUREMENT PERSPECTIVES - Tackling the liquidated damages issue

It takes many months, and even years, to plan and execute even the modest improvement.

On-site construction often will also stretch over a period of many months. As a result, the negotiation of service and material supply agreements will take place over a similarly protracted period of time.

The larger the improvement that is being made, the more pronounced the timing aspect of construction supply agreements becomes. Even in the case of a contract for an improvement of $10 million or less, some suppliers (known as the finishing trades) may not even be approached with respect to the project until it nears completion.

Thus, the negotiation of construction supply agreements is not only spread across several layers of contractual relations, it is also stretched over a lengthy period of time.

In recent years, there has been a growing tendency for municipalities to impose unrealistic times for completion in their construction contracts. In some cases, the time allowed is based upon an assumption of ideal weather and site conditions.

If any delay results from these or other causes, the contractor cannot possibly complete on time, with the result that it becomes liable to the withholding of liquidated damages from the payments to be made under the contract – usually at an arbitrary amount per diem.

Where the time allowed for the contract performance is insufficient, the usual consequence is for all bidders to include an allowance for anticipated liquidated damages that they will have to pay, in the contract price.

Where time is of the essence to a municipality, it should plan well in advance for the carrying out of the project. If necessary, it should obtain contractor advice and input on setting a realistic time to allow for construction of a given project.

When it tries to rectify a late decision to proceed by imposing unrealistic time limits, generally it simply ends up costing itself more money: the facility will not be ready on time, and (due to the liquidated damage clause) it pays more because it is delivered later than required.

A further problem is that such penalties are very often unenforceable. The enforceability of financial “penalties” in a construction contract will depend on whether the provision can be characterized as a penalty or as a requirement for payment of liquidated damages.

A penalty can be defined as a requirement for a fixed sum to be paid upon a default or breach of a specified clause(s) where the amount does not bear an apparent relationship to the actual loss suffered.

Often the penalty will be an amount well beyond the damages actually incurred. Such provisions are not legally enforceable.

Thus, caution should be exercised when fixing the penalty payment rate. If it is not, the owner may end up paying its contractor a premium, to offset the effect of a contractual provision that cannot be enforced.

It is always a good idea to have pre-defined rates, equations, and procedures in place before the contract starts. This will eliminate a range of issues from arising during the performance of the contract.

It is wise to specify clear and accurate formulae or methods to pro-determine values for items that affect the final price payable.

For instance, home office overhead rates can be preset and contract provisions can be included to establish a generally accepted manner for determining the equipment rates to be used in pricing change orders.

Specifying a realistic unit price, or a per diem value for extended project time is also a good idea.

Stephen Bauld is Canada's leading expert on government procurement. He can be reached at stephenbauld@bell.blackberry.net. Some of his columns may contain excerpts from The Municipal Procurement Handbook published by Butterworths.

last update:Sep 10, 2014

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