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Where a contractor entered into a design-build contract with the U.S. Navy to build four buildings at the Pensacola Naval Air Station, and included a liquidated damages (LD) provision in the subcontract with its subcontractor, that LD provision was enforceable despite evidence that the actual damages incurred by the contractor as a result of alleged delays by the subcontractor were far less than the LD amount, and despite the fact that the Navy did not impose any LDs on the prime contractor for delay.  In United States v. Dick Corporation, 2010 WL 4666747 (N. D. Fla. 2010), a Miller Act claim was filed against Dick Corp. by the United States on behalf of a subcontractor.  Dick made a counter-claim against subcontractor, arguing Dick was entitled to withhold payment and anything it owed to the subcontractor was more than offset by Liquidated Damages the subcontractor owed to Dick.  The subcontractor argued that the LD provision was unenforceable because (1) the Navy didn’t assess LDs against Contractor; (2) the sub caused no delay to trigger the LDs; and (3) the LDs constituted an unconscionable penalty – far exceeding actual damages sustained.  The court concluded that although LDs were “far in excess” of the actual damages, it was not possible to ascertain when the parties entered into the contract what the actual damages would be.  Even if Dick could calculate part of its potential actual damages when entering the contract, there were additional unascertainable factors. The LDs were not “grossly disproportionate to damages that might reasonably be expected to follow… from delays.”

A test established by the Florida Supreme Court, to determine if a liquidated damages clause will be upheld or stricken, was cited in this case as follows:  “First, the damages upon a breach must not be readily ascertainable.” “Second, the sum stipulated to be forfeited must not be so grossly disproportionate to any damages that might reasonably be expected to follow from a breach as to show that the parties could have intended only to induce full performance, rather than to liquidate their damages.”  In this case, the court found that it was because of factors that could have resulted in damages that were unascertainable as of the date of entering into the contract that the parties agreed to the liquidated damages provision.  As stated by the court: “Not only were Dick’s damages as a result of delay not ascertainable at the time the parties entered into the subcontract, but they also were not grossly disproportionate to damages that might reasonably be expected to follow from [subcontractor’s] work delays. Indeed, had the Navy assessed liquidated damages against Dick as a result of [subcontractor’s] delays, Dick’s actual damages could have exceeded its liquidated damages. The court therefore finds that the liquidated damages provision in the parties’ subcontract is valid and enforceable.”  It would have been possible that the subcontractor’s delays, for example could have delayed other trades and resulted in costs and possibly even damages that could not have been ascertained at the time the subcontract was entered into.

 

Comment:  It continues to baffle me when parties to a contract make the argument that the amount of damages calculated under a liquidated damages provision must be compared to actual damages sustained to determine whether the LD provision is reasonable and can be enforceable.  As the court here correctly decided, a comparison of LDs to actual damages is not the determinative factor in deciding whether an LD provision is unenforceable.  The concept is that at the time the contract is entered into it is not possible to readily ascertain what the actual damages from non-performance or late performance will be.  Since that is so, the parties establish a pre-determined amount of daily damages that they reasonably believe will cover whatever actual damages might result.  It doesn’t matter that the actual damages ultimately turn out to be a lot lower.  What matters is whether the LD amount when established at the time of contract negotiation was an amount that might reasonably be expected to result from actual damages, the amount of which could not at that time be ascertained.  If they are not grossly disproportionate “to damages that might reasonably be expected to follow from delays, LDs are generally enforceable even if it turns out that the actual damages are considerably less.

An interesting insurance question is sometimes asked concerning coverage for liquidated damages – particularly in the context of professional liability policies.   It is sometimes argued that the professional liability policy provides no coverage for liquidated damages because those damages are created by contractual agreement, and as such the contractual liability exclusion of the policy bars them from coverage.  If a court would award the amount of the LDs even at common law in the absence of the LD provision of the contract, the insurance policy would cover them to the extent they were caused by the negligent performance of the insured design professional.  However, what happens if as in a case like this one, it turns out that the actual damages are less than the pre-agreed LD amount?  Will the policy only cover the actual damages and not the full amount of the LDs that are assessed?   Even if there is a clear answer to that question, it is a rare case where the actual damages are ultimately determined and can be contrasted to the LD specified amounts.  More typically, the court simply enforces the LD amount because it is determined to be reasonably based and not unconscionable.  If that is the situation, will the contractual liability exclusion bar coverage for those LDs?   I have not seen any definitive opinion on that issue.  But I believe the coverage question can be framed as whether the damages awarded against the design professional result exclusively from the LD provision without regard to a finding of negligence and without regard to whether there were any actual damages.  If the design professional is found to be negligent, and that negligence caused some damage, one could make an argument that so long as the LD provision, when entered into, was a reasonable effort to establish what otherwise unascertainable actual damage amounts would be, the policy should cover those damages.  Indeed, it is possible that the amount calculated under the LD provision could be less than the actual damages if they could be ascertained.  Thus, the LD amounts claimed for coverage under the policy could be less than what would be required if actual damages could be calculated.  If the amount of actual damages cannot be ultimately ascertained, instead of this proving that coverage should be denied, it might instead tend to show that the LD provision was reasonable for the very reason that it is impossible to ascertain actual damages.

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. 14, No.1 (Jan 2012).

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