Consequences of Late Completion
Liquidated Damages and Bonus Clauses In Construction Contracts
Arthur O'Leary, FAIA, MRIAI
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Owners and contractors alike can and usually will lose money when their construction projects take longer than expected.
An extended construction period will cost the contractor the daily cash value of continuing superintendence, security, temporary facilities such as site office, telephone, power, toilets, transportation, fencing, and possibly hoisting and scaffolding. Home office support services must also be continued. In addition there is the interest loss on delayed payments and retainage.
When a construction contract is not completed on time it is recognized that the owner could also suffer substantial monetary damages such as loss of rental value, interest on invested funds, and rentals on duplicate premises, to name a few.
Some feel that the contractor’s actual cash losses do not provide a sufficient economic stimulus for timely completion. Many owners and their legal advisors feel that contractors require some additional financial incentive to complete their projects on time.
When the completion date is of significant economic importance to the owner, additional pressure can be applied by charging the contractor for overrunning the established date or by rewarding early completion. These ends may be accomplished by inclusion of a liquidated damages and/or bonus clause in the agreement.
Establishing the Construction Time
To analyze this problem it is important to know how the contractual completion date is usually set. There are two common possibilities: either the owner (or architect) sets a time period (or date) which is required or convenient, or it is established by the contractor at the time of bid submission.
In the first case the owner-established date might provide for a reasonably workable construction period, or it might be impractically short. Architects, in estimating a realistic time period, usually refer to the experience of previous contracts or will confer with contractors.
In the second case, the contractor sets the time period or completion date. Often, in competitive bidding, each bidder is asked to submit a proposed completion time along with the bid. The contractor with the shortest construction period might be favored over the lowest monetary bid, or the low bidder could be asked to meet the lowest quoted construction time.
In the haste and pressure of aggressive competitive bidding, insufficient thought is usually given to a realistic construction time schedule. Some bidders get carried away in the spirit of optimism and competitiveness and take a foolhardy chance on a tight or impossible time schedule.
Sometimes contractors will agree to unrealistic completion dates just to get the contract. The self-delusory expectation is that good fortune will somehow resolve the practical problems, so they take a chance.
It is seldom in the owner’s best interest to create an artificial demand for unrealistic early completion. If, on the other hand, it is an economic or practical necessity to have occupancy at a certain time, then the contractor should by all means be contractually involved in the effort to achieve the required deadline.
A liquidated damages clause providing for the contractor to forfeit a stipulated sum to the owner for each day of delayed completion will no doubt serve as an effective financial motivation to the contractor to complete on time. There is no question that it focuses the contractor’s attention on the time schedule.
Some contractors feel that if it is of value to the owner to gain early occupancy then the contractor should be rewarded with an early completion bonus. It could be a single stipulated sum for timely completion and/or an agreed sum per day of early completion. If this is what the owner and contractor agree to, then a bonus provision could be added to the liquidated damages clause. Architectural administration references and legal formbooks are loaded with appropriate clauses. See Sidebar for AIA’s suggestions.
Some owners cannot use the building if delivered early, so would not wish to pay a bonus. Their only interest would be in compelling timely completion and being compensated for monetary losses when the completion is late.
Liquidated damages cannot be assessed in the absence of a contract provision providing for it. If such clauses are going to be included in the agreement they must be available for the contractors’ reference and evaluation during the bidding period before the price is set. If they were imposed as new requirements after bid prices are revealed, an appropriate adjustment in the contract price would have to be considered.
Contractors generally spread the risk of paying liquidated damages by including similar clauses in their subcontracts.
Bonus Clauses: There is a persistent erroneous belief that liquidated damages clauses cannot be included in the absence of a bonus clause. This is not true. Either clause can be included with or without the other.
Deciding the Amount
The amount of liquidated damages should approximate the magnitude of actual monetary loss the owner would be likely to suffer if the project is not completed and ready for use at the designated time. The amount might be expressed as a lump sum for the first day of lateness with a smaller amount for each additional day thereafter, or it could be the same amount for each day the project remains uncompleted.
Amounts considerably greater than actual monetary losses would be considered punitive and should not be specified as courts and arbitrators are equally reluctant to enforce penalties. The actual damages likely to be incurred should be realistically estimated by the owner and can be rounded off for convenience.
Most contractors are opposed to liquidated damages provisions, considering them a penalty for failure to achieve the impossible. Others favor their inclusion, since it establishes a maximum value for damages. In the absence of the clause, the contractor could be held liable for the actual cost of consequential damages, which could be considerably higher.
Administering the Contract Provisions
When these types of contract clauses are included, it is vitally important to make a record of the day that construction actually started, the number of calendar days of construction time contemplated, and the target completion day. The date of commencement of construction is usually stipulated in the agreement and sometimes is stated in a notice to proceed issued by the owner or the architect on the owner’s behalf. (Note 1)
The term completion must be defined in a coherent and practical manner. (Note 2) The usual definition will be the date of substantial completion. This is defined in the AIA General Conditions as the date certified by the architect to be the date on which the work is suitable for its intended use, although there may still be miscellaneous punch list items left to be done. (Note 3)
Construction time should be expressed in calendar days or specific calendar dates. When expressed simply in days or in working days, disputes will inevitably develop as to exactly what is meant and how the time is to be calculated.
Most contracts contemplate that the completion time will be extended by construction changes that impact the critical path. All changes should be in writing, always with the time component noted. The time element should be agreed at the same time that the physical change and the price adjustment are discussed and not be allowed to slide to be taken up at some later time. Often the time factor, if immediately known, would have been unacceptable to the owner and the change order would have been canceled.
The owner’s pressure to maintain the completion date, if excessive, often leads to unfair decisions on contractor’s requests for time extensions for excusable delay and on the time element of change orders.
If the proposed completion date is inviolable to the owner, then the owner must actively cooperate by suppressing all changes that will affect the critical path and by timely performance of all contractual requirements. This would entail primarily making payments when due and making all decisions when needed. The owner could also interfere with the contractor’s timely completion by inexpert coordination of separate contractors, such as kitchen equipment installers, carpet layers, or landscape contractors.
Regardless of the owner’s and contractor’s best efforts to control construction delay, there will nearly always be some causes beyond anyone’s reasonable control. In addition to adverse weather, there are also possible labor disruptions, material and equipment unavailability, and actions of government.
The most contentious issue of all occurs when the contractor suddenly declares (with an air of finality) the project to be completed or announces that it will be completed on a particular day, say, 3 days hence. The owner, responding usually with equal vigor, declares that the work is nowhere near complete and certainly will not be in 3 days. The contractor’s riposte will always be that the remaining work is inconsequential, nit-picking, and consists solely of routine punch list items. The contractor insists that the owner can move in, minor pick-up work will be continued, and the job will be 100 percent complete in no time at all. The owner’s attitude is generally that after moving in they do not want odoriferous painters, noisy carpenters, untidy plumbers and electricians, and other disruptive workers interfering with the quiet, orderly, serene operation of their new building. The owner also is sure that the contractor’s normal excellent judgment is being clouded by the desire to avoid paying liquidated damages. And of course the contractor is utterly convinced that the owner has not overlooked the prospect of reducing the final payment by the exaction of several days of liquidated damages.
The problem is resolved by a fair determination by the architect. According to the AIA General Conditions (Note 4), the architect will determine the date of substantial completion. The architect must employ objective standards that will be fair to the interests of both owner and contractor. Whenever the completion determination would result in an exchange of money to or from the contractor or owner, there is always the potential for distrust, dissatisfaction, and a legal claim. Therefore the determination must be fairly made, based on prespecified criteria, and properly documented.
If the contract clause provides for a different degree of completion, such as 100 percent completion, or phased completions, the architect must use this as a measure and will make an appropriate and fair determination.
Some contracts include a separate liquidated damages clause covering the period between substantial completion and final completion. The owner’s potential damages would be less, as beneficial occupancy would have been achieved. The loss to the owner would be primarily the inconvenience and disruption of continuing construction, albeit of lesser scope.
Cost Plus Contracts
Liquidated damages provisions in cost plus contracts should stipulate that the contractor shall pay the liquidated damages to the owner as a direct reduction of the contract price and not be treated as a reimbursable cost.
Effectiveness of Financial Incentives
Contractors, unsurprisingly, do not favor financial threats like liquidated damages and will try to avoid the eventuality of paying them. Thus, if they have the opportunity of including an allowance for possible liquidated damages in their breakdown of estimated costs, they will do so. If all competitive bidders make such an allowance, the owner in effect will pay the liquidated damages if the project runs late and the contractor will gain a windfall if completion is on time or early. This would be equivalent to a bonus and would serve as a positive incentive for timely completion. A bidder who does not allow for liquidated damages could end up as low bidder. Timely completion in that case would be motivated primarily by the fear of having to pay liquidated damages.
Without a liquidated damages provision the contractor’s main incentives for timely completion would be in the avoidance of extended overhead costs and protection of its reputation in the community. However, when a contractor is working on several jobs at once, some with liquidated damages provisions and some without, the prudent course would be to apply limited resources to avoidance of paying liquidated damages.
A contractor attempting to earn the early completion bonus could overspend on overtime, supervision, and multi-shift work and not be any ahead, particularly if the job is completed only on time or a few days late, earning no early bonus and possibly incurring a few days’ liquidated damages.
Contractors under the pressure of overrunning the completion date will tend to be more aggressive in asserting extra time claims arising from change orders and inclement weather. Some will seek to shift responsibility to the owner and architect for every conceivable change in conditions, real and imagined.
Ideally, owners considering liquidated damage clauses will be better off with a competent contractor who has a reasonable time period in which to construct the project. Time extensions fairly granted and a realistic liquidated damages provision will not yield timely completion when the allotted construction time is insufficient or the contractor is incapable.
The problems inherent in various combinations of unrealistic contractual clauses, incompetent contractors, and insufficient construction time will not be resolved by harsh, unyielding contract administration. Moreover, timely completion cannot be achieved by imposition of a liquidated damages or bonus clause when the construction period is insufficient even with an unusually capable contractor.
The Architect’s Position
Contracts with liquidated damages and bonus provisions will be more time consuming to administer, as both owner and contractor will always be mindful of the monetary consequences of their own and the others’ actions. The architect will have more determinations to make and more disputes to resolve. The architect should monitor the contractor’s record keeping of weather conditions and must make fair determinations of all contractor requests for weather-related time extension. All change orders must consider the related time element.
The architect must be forever mindful of not being responsible for holding up job progress for which the owner will have to pay the contractor. The contractor will not look kindly on construction delay caused by the architect’s procrastination or lack of diligence in site inspections, shop drawing review, approvals, or decision making.
See AIA General Conditions, A201-1997, Subparagraphs 8.1.2, Date of Commencement, and 8.2.2, Owner’s Notice to Proceed
For a fuller discussion on completion, see Chapter 19, Closing Out the Job, in “A Guide to Successful Construction - Effective Contract Administration,” by Arthur F. O’Leary, FAIA, MRIAI, published by BNi Publications, Anaheim California.
See A201-1997, Subparagraphs 8.1.3, Date of Substantial Completion, and 9.8.1, Substantial Completion.
See A201-1997, Subparagraphs 4.2.9, 8.1.3, and 9.8.2
Liquidated Damages and Bonus Clauses
The following are suggested by the American Institute of Architects in its Guide for Supplementary Conditions (for use with General Conditions of the Contract for Construction, AIA document A201-1997, and Instructions to Bidders, AIA Document A701-1997), AIA document A511-1999:
9.11 Liquidated Damages: The Contractor and the Contractor’s surety, if any, shall be liable for and shall pay the Owner the sums hereinafter stipulated as liquidated damages for each calendar day of delay after the date established for Substantial Completion in the Contract Documents until the Work is substantially complete:__________________Dollars ($_________)
9.12 Bonus: The Owner shall pay as a bonus to the Contractor a sum of___________________Dollars ($_________) for each calendar day preceding the date established for Substantial Completion in the Contract Documents that the Work is determined to be substantially complete by the Architect.
These paragraphs are to be added to Article 9 of the supplementary conditions for the information of all bidders. They should also be added to the general contract agreement at Article 3 of A101-1997 when the basis of payment is a stipulated sum and at Article 4 of A111 when the basis of payment is the cost plus a fee.
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