Let’s be reasonable

The difficulty of determining liquidated damage provisions

August 05, 2015

Liquidated damage provisions, under which a project owner sets a predetermined daily sum for a contractor’s failure to complete a project on time, were, at one time, viewed by the courts as penalties and ruled unenforceable.
However, courts eventually came to recognize the value of such provisions as reducing uncertainty by fixing the owner’s damages and making it easier for courts deciding late completion damage cases. 
Today, liquidated damage provisions are enforced unless the amounts are deemed unjust or oppressive, or are disproportionate to the owner’s actual damages. A question sometimes arises concerning the point in time at which the liquidated damage amount is judged for reasonableness—i.e., prospectively when the parties enter into the contract or retrospectively at the end of the project. 
The Court of Appeals in Mississippi recently struggled with this question. 
In Hovas Construction Inc. v. Bd. of Trustees of Western Line Consol. School Dist., 2012 WL 3799071 (Miss.App. Sep. 4, 2012), a prime contractor renovating a public school completed the project 39 days late, and the owner reduced the contractor’s final payment to account for the specified $500 per day liquidated damage amount. The prime sued on the grounds the owner incurred no actual damages. The trial court focused on the reasonableness of the $500 amount set by the owner when it drafted the contract and concluded that it represented a reasonable sum given the overall size of the contract. The court ruled for the owner. 
On appeal, the Mississippi Court of Appeals agreed. However, the case was not unanimous and the majority, concurring and dissenting opinions by the Court of Appeals justices highlighted a conflict within Mississippi concerning whether, as argued by the contractor in that case, an owner’s actual damages as determined at the end of the project are relevant to determining the reasonableness of the contract’s liquidated damages amount.
In its majority opinion, the Court of Appeals emphasized the trial court’s determination that the owner had, in fact, incurred damages as a result of the contractor’s failure to complete the project on time. However, justices authoring the concurring opinion, while agreeing with the ultimate decision to rule for the owner, rejected any notion that a retrospective inquiry of an owner’s actual damages should be performed. Those justices believed that a determination of whether a stipulated sum constitutes enforceable liquidated damages or an unenforceable penalty should be based on “the terms and inherent circumstances of each particular contract, judged at the time of the making of the contract, not as at the time of the breach.” 
Justices in the dissent took the opposite approach and argued that if, as the trial evidence seemed to suggest in this case, an owner incurs no damages, enforcement of a liquidated damages provision would amount to a penalty. In support, these justices recited a case decided under Mississippi law in the U.S. Court of Appeals for the Fifth Circuit in which a contractor building a bridge for the city of Greenville completed the bridge approximately 96 days late. The court in that case determined that in spite of the contractor’s delay, the city had incurred no actual damages because it suffered no delay in actual use of the bridge. These justices thus believed a retrospective view should be applied.
The Hovas case suggests a state of confusion in the law of Mississippi concerning whether a prospective or retrospective approach is used to determine the enforceability of liquidated damages provisions. In all other states, courts have either definitively chosen one of the two approaches, or the issue has never arisen and thus parties are free to argue the adoption of the approach that is most advantageous to their case. 
Knowing which methodology is used by a particular court is important to contracting parties because circumstances surrounding the owner’s situation frequently change after a project begins. For example, a state highway department might include in its calculation of liquidated damages the loss of use of a completed roadway, but by the time a late project is completed there could be other reasons unrelated to the contractor that have prevented the roadway from being utilized. In such an instance, the methodology used to judge the fairness of the liquidated damages sum is important to both the owner and the contractor. R&B

Larry Caudle

Larry Caudle is a principal in Kraftson Caudle LLC, a law firm in McLean, Va., specializing in heavy-highway and transportation construction.

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