Tuesday, March 12, 2024

Enforceability of Contract Provisions Extending Liquidated Damages Beyond Substantial Completion

This post takes a look at the enforceability of contract provisions providing for liquidated delay damages after substantial completion. Typically, the assessment of liquidated delay damages ends at substantial completion of a project. However, various standard form contracts, including some of the ConsensusDocs and EJCDC contracts, contain elections allowing for the parties to agree on the use of liquidated damages for failing to achieve substantial completion, final completion, or project milestones. The standard language in the AIA A201 leaves it up to the parties to define the circumstances under which liquidated damages will be awarded.

Courts are split on the enforceability of provisions that seek to assess liquidated damages beyond substantial completions. Courts in some jurisdictions will not impose liquidated damages after the date of substantial completion on the ground that liquidated damages would otherwise become a penalty if assessed after the owner has put the project to its intended use.  Perini Corp. v. Greate Bay Hotel & Casino, Inc., 129 N.J. 479, 610 A.2d 364 (1992). When the terms are clear, other jurisdictions will enforce contract terms providing for liquidated damages until final completion, even if the owner has taken beneficial use of the facility. Carrothers Const. Co. v. City of S. Hutchinson, 288 Kan. 743, 207 P.3d 231 (2009).

In Power Constructors, Inc. v. City of Ketchikan, 923 F.2d 863 (9th Cir. 1991), a public owner sought to recover liquidated delay damages beyond substantial completion pursuant to a contract provision that provided for liquidated damages for “each and every day that the work and any specified portions thereof are not completed . . .” The district court held that the entire provision was an invalid penalty because it applied after substantial completion to minor and inconsequential breaches.  

The Ninth Circuit reversed the district court and held that under Alaska law, the court should have upheld that portion of the liquidated damages provision that was not a penalty and that the public owner was entitled to recover liquidated damages until substantial completion.

However, other courts have allowed liquidated damages beyond substantial completion where the contract specifically provides for such. In Reliance Ins. Co. v. Utah Dept. of Transp., 858 P.2d 1363 (Utah 1993), the Utah Supreme Court upheld a provision in a state highway contract that provided for liquidated damages of $600 per day when “any work shall remain” on the project.

The Reliance Ins. court rejected the surety’s argument that liquidated damages should end at substantial completion. The court noted that the contract between the parties does not provide for liquidated damages to end at substantial completion, but rather, final completion as determined by the UDOT engineer. The court went on to hold that the provision was unambiguous and that the parties could have used substantial completion as the date for ending the assessment of liquidated damages if they so intended. The Reliance Ins. court noted, however that there could be a case when the work remaining on the project was so trivial that assessing the entire liquidated damages amount could result in gross unfairness – but that was not so in the case before the court.

Similarly, in Ledbetter Bros. v. N. Carolina Dep't of Transp., 68 N.C. App. 97, 314 S.E.2d 761 (1984), the Court of Appeals of North Carolina enforced a provision in a public highway contract which assessed liquidated damages until final completion of the work.

The liquidated damages provision was contained in the standard specifications issued by the state highway commission and incorporated in the contract by reference. The provision provided in pertinent part: “a sum of money in the amount stipulated in the contract will be charged against the Contractor for each calendar day that the work remains uncompleted after the expiration of the completion date . . .”

The court noted that liquidated damages provisions have long been held to be valid and an appropriate means of inducing timely performance. “It would frustrate this policy, and increase the likelihood of inconvenience and danger to the public to allow disputes over substantial performance to affect such provisions.”

California courts have also upheld contract provisions providing for liquidated damages on a school construction project until “final completion” rather than “substantial completion.” Rejecting the contractor’s argument that liquidated damages could not be awarded after substantial completion, the court noted that because the parties had contracted for a complete building, not a substantially complete one, liquidated damages until final completion were appropriate. Vrgora v. Los Angeles Unified Sch. Dist., 152 Cal. App. 3d 1178, 1187 (Ct. App. 1984).

Based on the case law, it appears that many jurisdictions will enforce contract provisions providing for liquidated damages beyond substantial completion. Provisions as such should be unambiguous in their terms and – even considering that some jurisdictions will not evaluate the gravity of the liquidated penalty versus actual delay damages – in most instances liquidated damages should be predicated upon a reasonable estimate of the damages to the owner from the failure to achieve final completion.

Author and Editor Stu Richeson is an attorney in the litigation section of Phelps' New Orleans office, primarily focusing on commercial litigation with an emphasis on construction matters, intellectual property issues and insurance.

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