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When the amount of damages is difficult to predict, a liquidated damages clause will generally be upheld unless the court determines that the clause was intended to be a penalty rather than liquidated damages. In Safeco Credit v. U.S., 44 Fed.Cl. 406 (1999), a contractor was assessed damages by the Department of Navy for late completion of a contract. The contractor argued that the delays were caused by 53 contract modifications by the Navy. The Navy granted time extension change orders for the specific phase of the project that was affected by each change order. It did not, however, specifically agree to extend the start date or date of completion of any other phase of the project that might arguably be affected by the delayed completion of the first phases.

Contractor argued that if the Navy extended the time for completing one phase, it must be assumed that the time for starting and completing the next phase would likewise be granted a time extension. Moreover, the contractor argued that the dollar amount of the liquidated damages was punitive rather than reasonable, and did not follow the rules and procedures of the Navy’s contract manual. In reviewing whether the Navy had properly assessed liquidated damages and denied the contractor’s claim for equitable adjustment for delay to the overall project, the court stated that the contractor has the burden to establish that the liquidated damages clause was intended to operate as a penalty. To prove that, it is necessary to ask three things:

(1) Did the parties intend liquidated damages or a penalty?

The terms of the contract are the best evidence of the party’s intent.

(2) Was the amount of damages that would be caused by a breach uncertain in amount or difficult to determine?

The more difficulty there would be in proving that a loss has occurred or the amount of the loss in the event that it occurs, the easier it is to show that the amount fixed as liquidated damages is reasonable. The court evaluates this question based on the reasonable expectations of the parties as of the date the contract was executed.

(3) Does the amount of damages bear a reasonable relationship to actual damages that could be sustained in the event of a breach?

The amount is reasonable if it approximates the loss anticipated at the time the contract is executed, even though it may not approximate the actual loss.

In this case, the court found that the contractor failed to prove that the liquidated damages clause operated as a penalty. The amounts were based on the Navy Contract Manual, but to the extent that they differed, the Navy had followed required Navy procedures to justify the higher amounts set. On the issue of whether the project completion date should have been extended due to the extensions on the individual phases, the court found that the change orders were self contained and that “the terms of the contract modifications at issue here make it clear that a change in the completion date for one phase of the contract does not lengthen the period of time in which a subsequent phase was to be completed, unless expressly provided.” No provision was made for any cumulative impact. For these reasons, the court granted the Navy’s motion for summary judgment against the contractor.

About the author: Article written by J. Kent Holland, Jr.,  a construction lawyer located in Tysons Corner, Virginia,  with a national practice (formerly with Wickwire Gavin, P.C. and now with Construction Risk Counsel, PLLC) representing design professionals, contractors and project owners.  He is founder and president of a consulting firm, ConstructionRisk, LLC, providing consulting services to owners, design professionals, contractors and attorneys on construction projects.  He is publisher of ConstructionRisk.com Report and may be reached at Kent@ConstructionRisk.com or by calling 703-623-1932.  This article is published in ConstructionRisk.com Report, Vol. 2, No. 6 (Jun 2000).

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