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Supreme court sides with contractor, denies city’s attempt for liquidated damages

Article January 16, 2004
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Many state DOT Disadvantaged Business Enterprise (DBE)
programs include a provision entitling the state DOT to recover
“liquidated damages” for any shortfall in DBE participation. For
many years I have suggested that such provisions are an unenforceable penalty
because the amount bears no relationship to any damages suffered by the state
DOT as a result of the contractor’s failure to meet the DBE goal.
Recently in City of Rochester v. E & L Piping, Inc., 764 N.Y. S.2d 514
(2003), the New York Supreme Court ruled in favor of the contractor based on a
finding that the damages were a penalty.

E&L entered into a contract with the city to be the
prime contractor on the Rochester War Memorial renovation project to perform
heating, ventilation and air conditioning. The contract required E&L to
comply with the city and state M/WBE utilization requirements and an
African-American-owned business goal of 8.45% and a women-owned business goal
of 8%.

The contract contained the “M/WBE Utilization
Requirement, City of Rochester Minority and Women Business Enterprise (M/WBE)
Utilization Goal Construction Setasides.” Under the terms of this
utilization requirement were clauses establishing liquidated damages of 125% of
the M/WBE goal for noncompliance.

E&L sought summary judgment dismissing the city’s
assessment of liquidated damages on the grounds that the contractual remedy of
liquidated damages for a breach of the M/WBE plan is an unenforceable penalty.
The city asserted that the liquidated damages provision was valid because it
was intended to correct the effects of discrimination in the city’s
procurement. The city also asserted the socioeconomic benefits of the program
were large.

No witness protection

In analyzing the arguments, the Supreme Court first
discussed the general legal principles that apply to a liquidated damage clause
in a contract, stating, “A contractual provision fixing damages in the
event of breach will be sustained if the amount liquidated bears a reasonable
proportion to the probable loss and the amount of actual loss is incapable or
difficult of precise estimation . . . If, however, the amount fixed is plainly
or grossly disproportionate to the probable loss, the provision calls for a
penalty and will not be enforced.” The issue for the court was whether
the city’s M/WBE liquidated damages clause was grossly disproportionate
to the probable harm or loss to the city.

The court found the city had failed to demonstrate any
probable damages at the time the parties entered into their agreement that
would justify, in the event of a breach, the sum allowed under the liquidated
damages provision. The contractual provision for damages in the sum of 125% of
any shortfall of the Approved M/WBE Utilization Plan was not an estimate of the
extent of injury that would be suffered by the city.

The court also found that liquidated damages were not
supported by the city’s witnesses. The purchasing agent testified that
the 125% of the shortfall due for failure to comply is a penalty and not liquidated
damages. The M/WBE officer testified he did not know why the assessment of 125%
was selected or who selected that number. The city’s director of
finance’s affidavit stated that the purpose of the liquidated damages
provision for violation of the M/WBE “was to correct and/or ease effects
of past discrimination and to assist in correcting future
discrimination.” No city witness could articulate a reason or basis for
the 125% figure or how the city was damaged by the breach of contract.

The court rejected the city’s argument that the
liquidated damages clause was intended to compensate an abstract loss for past
discrimination and to achieve a public benefit is insufficient to show that
this is an enforceable liquidated damages clause. Instead the evidence
presented and the language of the liquidated damages clause demonstrates that
the amount fixed is plainly disproportionate to the probable loss to the city
and, therefore, it is an unenforceable penalty clause.

What does the DBE provision in your state DOT contract
provide? If the remedy for failure to meet the DBE goal is liquidated damages,
it is likely unenforceable.

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