The Enforceability of Liquidated Damages for Delays to Final Completion
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By Robert L. Smith and Kate E. Seivert
Rob and Kate are members of the firm’s Construction Law Department. Rob can be reached at 612.359.7648 or rsmith@fwhtlaw.com. Kate can be reached at 612.359.7678 or kseivart@fwhtlaw.com.
Liquidated damages are a common facet of construction contracts, setting forth a predetermined amount that a contractor must pay an owner for each day that a project is late. While liquidated damages are usually based upon the date on which a project is scheduled to reach substantial completion, more and more owners are attempting to include contract provisions that impose liquidated damages for failure to timely achieve final completion as well. As discussed below, clauses that attempt to impose liquidated damages based on delays to final completion are problematic and may be unenforceable.
Minnesota Law on Liquidated Damages
In Minnesota, as in most other states, liquidated damage amounts cannot be a penalty. When a liquidated damages clause provides for damages amounts that are “manifestly disproportionate” to the damages actually sustained by an owner, the provision is a penalty and unenforceable. Gorco Const. Co. v. Stein, 99 N.W.2d 69, 75 (Minn. 1959).
In determining whether a liquidated damages clause is valid, rather than an impermissible penalty, Minnesota courts consider: (1) whether the liquidated damages amount is a reasonable forecast of just compensation for the harm caused by the breach; and (2) whether the harm is incapable or very difficult of accurate estimation. Bellboy Seafood Corp. v. Nathanson, 410 N.W.2d 349, 352 (Minn. Ct. App. 1987). Provisions in a contract for liquidated damages will be deemed a penalty and therefore unenforceable where the liquidated damages “are so great as to bear no reasonable relation to the amount of actual injury suffered by the breach.” Stanton v. McHugh, 296 N.W. 521, 522 (Minn. 1941).
Substantial Completion versus Final Completion
Substantial completion is generally defined as the point in time when an owner can use a project for its intended purpose. In contrast, final completion is typically the point in time – after substantial completion – when “punch list” work that does not meaningfully impact the owner’s use of the project has been completed and administrative requirements have been met.
Because an owner cannot use its project until substantial completion is achieved, it often makes sense for liquidated damages to be imposed based on the failure to timely achieve substantial completion. This is true because it can be difficult to accurately estimate the impact of failure to achieve substantial completion by the agreed-upon date on damage elements such as lost revenue. On the other hand, because an owner gets the benefit of the construction’s intended purpose at substantial completion, it is much less clear whether liquidated damages are appropriate for failure to timely achieve final completion. After substantial completion, the owner’s damages likely do not include lost revenue and are likely limited to items such as increased contract administration expenses.
Liquidated Damages for Final Completion – Mixed Decisions
The Minnesota Supreme Court made clear that liquidated damages clauses are unenforceable when the measure of actual damages are ascertainable (which is often the case for post-substantial completion damages) and the liquidated damages amount is disproportionate to the actual damages, writing:
This court has held that where the actual damages resulting from a breach of the contract cannot be ascertained or measured by the ordinary rules, a provision for liquidated damages not manifestly disproportionate to the actual damages will be sustained. On the other hand, when the measure of damages resulting from a breach of contract is susceptible of definite measurement, we have uniformly held an amount greatly disproportionate to be a penalty.
Gorco, 99 N.W.2d at 75 (emphasis added).
And while Minnesota courts have not yet addressed the question of whether contract clauses attempting to assess liquidated damages for delays to final completion are enforceable, this issue has been ruled on by a number of other courts. Most courts have ruled that liquidated damages for failure to timely achieve final completion are nothing more than a penalty and, therefore, are not enforceable.[1]
For example, in S.L. Rowland Const. Co. v. Beall Pipe & Tank Corp., 540 P.2d 912, 914 (Wash. Ct. App. 1975), the Washington Court of Appeals concluded that a contract provision which attempted to impose liquidated damages after substantial completion was an unenforceable penalty. The S.L. Rowland case involved the construction of a steel pipeline. The parties’ contract included a provision imposing liquidated damages of $150 per day for failure to achieve final completion even though the pipeline had been put into full operation at substantial completion. The court reasoned that the liquidated damages provision was not a reasonable forecast of any actual damage incurred related to the failure to complete the work after the pipeline was in full use. Thus, the provision was unenforceable after the pipeline was in full use, “since after that date it had an in terrorem effect of inducing a performance rather than the permitted effect of compensating for loss.”
Similarly, in Stone v. City of Arcola, 536 N.E.2d 1329, 1338 (Ill. App. 1989), the owner attempted to enforce a liquidated damages clause prescribing such damages for failing to complete “all work”, regardless of whether the project was substantially complete. The court held that this provision was unenforceable, reasoning that “[s]ince the project was sufficiently complete at that time to be used for the purpose for which it was intended, then it would seem appropriate to construe the liquidated damages provision to close at the time of substantial compliance, even though there may be minor repairs, adjustments, or finishing work remaining.”
In contrast, some courts have examined clauses that impose liquidated damages for failure to timely achieve final completion and have come to a different conclusion. For example, in Carrothers Const. Co. v. City of S. Hutchinson, 207 P.3d 231 (Kan. 2009), the contract imposed certain dates on which aspects of the project were to be completed, as well as liquidated damages related to each of those dates, including $850 per day for each day after substantial completion was achieved. The Kansas Supreme Court upheld this provision, noting that the contract “clearly expressed the parties’ intent that liquidated damages continue past substantial completion.” Notably, unlike the S.L. Rowland case, the owner presented evidence that meaningful damages were incurred after substantial completion. In particular, the project engineer testified that the damages incurred for a delay in substantial completion compared on a prospective basis at the time of contracting with the damages for a delay in final completion, and that there was “really no difference in the risk to the City between a late substantial completion date and a final completion date.”
Similarly, in Ledbetter Bros. v. N. Carolina Dep’t of Transp., 314 S.E.2d 761, 766 (N.C. Ct. App. 1984), the North Carolina Court of Appeals evaluated a liquidated damages clause which imposed damages for the contractor’s failure “to complete the work by the completion date.” The court permitted the provision to be enforced, assessing liquidated damages through the “completion date.” In doing so, the court noted that this completion date was based on the date on which the work was “satisfactorily completed” and that such “satisfaction” provisions clearly invest the inspecting party with discretionary power to reject, subject only to restrictions of good faith.
Ultimately, whether a court will be willing to enforce a liquidated damages provision after substantial completion depends on the particular facts and circumstances of the project. If an owner can demonstrate that it incurred actual damages for failure to achieve final completion within a certain period of time after substantial completion and can show that those damages were incapable of accurate estimation, a court may very well enforce the provision. If, on the other hand, an owner suffers no significant damages after substantial completion, or if the owner’s damages are items that can easily be proven (such as increased costs paid to inspectors or engineers), a court is likely to find such a clause to be unenforceable.
Practical Advice
Owners that are contemplating whether to include clauses in their contracts that impose liquidated damages after substantial completion should take the time to identify the damages they are likely to incur and realistically assess whether there is a need for liquidated damages after substantial completion. It may be more appropriate for an owner to simply pass through actual damages, such as increased inspection and engineering costs.
Contractors, in circumstances where contracts can be negotiated, should insist that the owner explain the basis for wanting to include final completion liquidated damages amounts. A contractor considering agreeing to such a clause should ensure that the proposed liquidated damages amounts are a realistic estimate of the owner’s damages rather than a penalty.
Finally, contractors facing claims from owners for final completion liquidated damages should consider challenging such damages as an unenforceable penalty. If the owner has suffered no or very little harm, a court may very well be willing to declare the liquidated damages clause invalid.
[1] Perini Corp. v. Greate Bay Hotel & Casino, Inc., 610 A.2d 364, 376-77 (N.J. 1992) (finding that liquidated damages imposed after the owner puts the project to beneficial use or otherwise occupies the project are considered a penalty); Am. Druggists Ins. Co. v. Henry Contracting, Inc., 505 So. 2d 734, 738-39 (La. Ct. App. 1987) (ruling that, after substantial performance, a contractor is entitled to recover the contract price less the amount necessary to perfect or complete the work); Phillips v. Ben M. Hogan Co., 594 S.W.2d 39, 41 (Ark. Ct. App. 1980) (“[W]here a construction contract is substantially performed within the time limit, delay in the completion of minor details which does not cause material damage to the project will not subject the builder to liquidated damages.”); Page v. Travis-Williamson Cnty. Water Control & Imp. Dist. No. 1, 367 S.W.2d 307 (Tex. 1963) (“After the date of occupancy the owner is entitled only to his actual damages.”); Appeal of Gaffny Corp., ASBCA No. 39740, 94-1 B.C.A. (CCH) ¶ 26522 (Nov. 22, 1993) (noting that the government may not assess liquidated damages after substantial completion when only punch list items remain even if it does not occupy the project at that time); Nippo Corp./Int’l Bridge Corp. v. AMEC Earth & Envtl., Inc., No. CIV.A. 09-0956, 2013 WL 1311094, at *54–55 (E.D. Pa. Apr. 1, 2013) (no entitlement to withhold liquidated damages after substantial completion).
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