Contract Terms – Liquidated damages a headache not a solution!

In large commercial construction contract Liquidated damages have been used for a very long time to compensate the Principal Contractor for a delay in completion of work beyond a concrete date. Most of the time, this is due to the follow on effect on other contractors and the timeline of a project.

It is worthwhile considering, on projects where key milestones are tight and it is highly likely disputes over extending time will arise, enforcement of liquidated damages under the contract will be arduous, costly and time consuming to both parties. As an alternative perhaps an “incentive provision” for completion on time is a more productive outcome.

ARE LIQUIDATED DAMAGES BEST?

In many Contracts, having a provision that deals specifically with delay liquidated damages (Delay LDs) might suit both parties. Principals can avoid the difficulty (and expense) of proving “actual damages” and contractors have certainty about potential exposure in the event of late completion of a project.

The Court will generally enforce a delay LD, provided the Delay LDs are a genuine pre-estimate of the loss likely to be incurred by the principal due to delayed completion.

Having a clause providing for a Delay LDs is likely to cause certain responses:

  • contractors will factor in the price the risk of a Delay LD;
  • contractors usually dispute open ended liability for liquidated damages; and
  • the contractor’s entitlement to an extension of time (EOT) is most likely to occur, which is an administrative headache, and may relieve the contractor of liability.

ALTERNATIVE THINKING INCENTIVE OPTIONS

As a positive alternative, Principals may use a Bonus or incentive payment to avoid bad behaviour and focus on the contractor achieving early or on time completion. This might avoid the preparation of EOT claims and the management of disputes.

Under an incentive scheme, if completion is achieved on or before a specified date, the contractor will be entitled to an incentive payment.

Consider the following methods to structure an incentive scheme:

  • A ‘hard date’ for completion whereby 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 at all.
  • A “progressive reduction” in the incentive payable if completion occurs after the specified completion date (either a decrease by a particular amount each day or a stepped reduction upon specific future dates).
  • A “milestone system” whereby the contractor is offered an incentive payment for each portion of the works that is completed on time (useful if the works are to be completed in distinct stages). 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.

ISSUES TO CONSIDER

An issue to consider in structuring an incentive scheme is whether the date for completion and payment of incentive can be extended?

Consider the following options:

  • The contractor might not be entitled to an EOT in any circumstance. The rationale for such an approach is a mutual sharing of risk and desire to avoid time and resources being consumed in preparing and responding to EOT claims. Contractors may be more comfortable with such an arrangement where there is limited scope for the principal to cause delay and/or the majority of delay risks are known and capable of being managed or reduced by the contractor.
  • The contractor is entitled to an EOT for a range of specified events (similar to a traditional contract) including principal caused delays and ‘neutral’ causes of delay ( worksite latent conditions, directions by statutory authorities, weather events).
  • An intermediate position might be that the contractor is only entitled to an EOT for caused solely by the Principal or delays due to force majeure.

YOUR PROJECT DOES AN INCENTIVE FIT?

Whether completion incentives promote on-time completion better than Delay LDs or result in fewer disputes, is a matter yet to be determined. However when projects need to get done on time perhaps this is a better way of achieving the outcome, that is with a carrot not a stick!

Use of incentive schemes should not be seen as the solution for all potential disputes associated with a traditional Delay LDs clause. Consider these points:

  • Any mechanism to extend the completion (incentive) date may still result in the parties becoming distracted by disputes over EOTs to that date.
  • Where the contractor does not achieve completion on time and is not entitled to receive an incentive payment, in the absence of Delay LDs, will there be sufficient incentive for the contractor to complete the works in a timely manner (other than minimising the contractor’s own costs if completion is not achieved on time)?
  • What is appropriate as an incentive scheme will depend on the nature of the particular project. For a project where on-time completion is critical (e.g. a construction or testing contract for a major infrastructure project) 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.

We are happy to assist clients drafting General Terms and Conditions for Tenders and Projects where these liquidated damages clauses appear. http://www.crillylaw.com.au

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