Liquidated Damages: What Every Contractor Needs to Know

Author, Andy Roberts, Account Executive, Rancho Mesa Insurance Services, Inc.

For a surety agent and underwriter, there are specific provisions within a contract that are important. One of the more critical provisions, references Liquidated Damages (LD). Often overlooked by contractors, LDs represent important elements of the contract that can cause significant financial losses on a project. So what are LDs; why are they important; and, what can contractors do to make sure the LDs in their contracts are fair?

Liquidated damages are daily charges within a contract that come into effect when there are delays on a project. The amount of the charge is spelled out within the contract, usually as “$X amount per day,” and are put into place to compensate the project owner for losses they may experience when a project’s completion is delayed. While that seems straightforward, this provision is very important and contractors need to understand what can happen if LDs are enforced on a project because of their delay.

If an owner is assessing liquidated damages on a project, the concern is that the contractor is going to start minimizing profits and depending on the amount, it could happen very quickly. Additionally, as those profits drop, cash flow can become an issue. This will lead to a potential default due to the financial distress which would trigger the surety’s involvement. There are a couple of ways contractors can mitigate their exposure to liquidated damages.

First, contractors should try to limit their exposure by capping the amount of the damages that can be assessed. We often see flow down provisions within subcontracts, where the higher LDs are used and it doesn’t make sense for the sub-contractor to take on that risk when their contract amount is significantly smaller than the prime contract amount. Second, contractors should try to negotiate terms that would limit their exposure to the damages that they cause.

While the liquidated damages provision within construction contracts is often overlooked, the daily amount that can be assessed can quickly become significant and should be considered prior to signing a contract. 

Should you have more specific questions about LDs within your contract, give me a call at (619) 937-0166 or email me at aroberts@ranchomesa.com.