Let's be reasonable

Considering the enforceability of liquidated damages clauses

Larry Caudle / November 04, 2016
Larry Caudle

Nearly all public construction contracts contain liquidated damages clauses.

These clauses are beneficial because they add certainty to the risk of late completion. Otherwise, the sky is the limit, and an owner could claim any damages the parties could have reasonably contemplated at time of contracting.

Historically, liquidated damage clauses were held in disfavor and considered by courts as devices to extract penalties and forfeitures. They were, therefore, deemed against public policy. Over time, the rule evolved that such devices would be recognized as a useful commercial tool to avoid litigation when determining actual damages.

Today, the generally observed rule is that liquidated damages clauses are enforceable as long as the owner’s damages from late completion were difficult to determine at the time of contracting and that the stated amount is a reasonable approximation. But will a court ignore an owner’s actual damages and focus solely on whether the prescribed daily amount was reasonable at time of contracting? There are actually two views; a case decided in Kentucky illustrates one such view.

Mattingly Bridge Co. v. Holloway & Son Constr. Co., 694 S.W.2d 702 (Ky. 1985) involved a project the prime contractor, Holloway, performed for the Kentucky Department of Highways. Holloway subcontracted with Mattingly to perform the bridge work on the project. The subcontract included a liquidated damages clause, which specified $750 per day “for each and every day after the fixed date of completion which the work hereby contracted for remains wholly or partially uncompleted [until] the work provided for in this contract has been completed and accepted by the owner.” The subcontract required Mattingly to complete its work on Nov. 15, 1971, whereas Holloway had until Dec. 1, 1971, to complete the project.

Holloway completed the project eight months late, but the Department assessed only 171⁄2 days of liquidated damages at the prime contract rate of $750. Nevertheless, Holloway insisted that it was entitled to recover from Mattingly $750 per day for the entire period between Nov. 15, 1971, and the date the Department accepted the project.

At trial, the court determined that “the whole of the delay” in completing the project was attributed to Holloway and not to Mattingly, even though Mattingly also failed to complete its work on time. It, therefore, ruled that the subcontractor was not indebted to the prime.

In a somewhat confusing and unpublished appeals decision, the Kentucky Court of Appeals remanded the case back to the trial court to determine Mattingly’s liability for liquidated damages. Without changing its conclusion that Mattingly was not responsible for the delay, the trial court interpreted the Court of Appeals’ statement of the law of liquidated damages and awarded Holloway the full liquidated damages sum it requested. Mattingly appealed. 

The Kentucky Supreme Court recognized the parties’ right to fix a completion date in the subcontract different from the prime contract and that if the subcontractor fails to complete within the time prescribed, the prime contractor need not prove its damages. But it also cautioned that the prime contractor’s recovery cannot be unlimited and is governed by both the contract and the law of liquidated damages. The court held that by reciting the “final acceptance by the Department” in the liquidated damages clause, the contract clearly limited the assessment of damages to that date. But the court also recognized that Holloway had been assessed only 171⁄2 days of liquidated damages by the Department. The court was thus faced with deciding whether, although the daily amount was a fair and reasonable estimate at time of contracting, it should consider the prime contractor’s actual damages.

The court turned to Section 356(1) of the Restatement (Second) of Contracts, which provides that liquidated damages must be in an amount “that is reasonable in light of the anticipated or actual loss” and interpreted that language as allowing it to consider (after the fact) the owner or prime contractor’s actual damages. It thus awarded Holloway only 171⁄2 days of liquidated damages. This is known as the retrospective approach.

The other is known as the prospective approach and allows a court to examine the reasonableness of liquidated damages solely on the facts at time of contracting. States are pretty evenly split in their use of these two approaches. A contractor’s knowledge of a particular state’s approach could come in handy if circumstances during a project substantially reduce an owner or prime contractor’s damages for late completion.

About the Author

Caudle is a principal in Kraftson Caudle LLC, a law firm in McLean, Va., specializing in heavy-highway and transportation construction. Caudle can be contacted via e-mail at [email protected]

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