Simon PLC Attorneys & Counselors – September 2025 Memorandum
Construction Contracts and Minimizing Risk: Liquidated Damages Clauses
Troy, Michigan – In the high-stakes world of construction, with its complex projects and potential for costly setbacks, contracts serve as the crucial backbone, bringing structure and clarity to the collaborative efforts of numerous parties. They are the legal documents that outline the intricate details of a project, including:
- Scope of work: What exactly needs to be built or accomplished.
- Timelines and schedules: Start and completion dates, key milestones for different phases.
- Payment terms: How and when payments will be made to contractors, subcontractors, and suppliers.
- Responsibilities: Clearly define who is responsible for each task, including permits, inspections, and materials.
- Risk allocation: Identifying potential risks and assigning responsibility to the party best equipped to manage them (e.g., owner for design, contractor for construction methods).
- Dispute resolution: Mechanisms for resolving disagreements that may arise during the project (e.g., mediation, arbitration, or litigation).
- Warranties and guarantees: Protecting the owner from defects and ensuring the work meets agreed-upon quality standards.
- Insurance and bonding: Protecting both the owner and contractor in case of accidents or other issues.
- Change order procedures: How changes to the project’s scope, timeline, or costs will be approved and documented.
- Compliance: Ensuring the project adheres to local, state, and federal laws and regulations.
Why contracts are so important:
- Legal Protection: Contracts clearly outline the rights and responsibilities of all parties involved, providing legal recourse if one party fails to meet its obligations.
- Dispute Prevention: Well-drafted contracts minimize misunderstandings and disputes by establishing clear expectations and processes for resolving issues.
- Project Management: Contracts help manage projects effectively by setting out specific timelines, milestones, and payment schedules.
- Cost Control: Contracts can provide clear guidelines for payment, reducing the risk of unexpected expenses and ensuring projects stay within budget.
- Risk Mitigation: By allocating risks appropriately, contracts can help to prevent or mitigate the impact of unforeseen challenges and reduce the potential for costly delays or issues.
Well-defined and comprehensive construction contracts are paramount for successful project completion. They provide a roadmap, foster collaboration, reduce the likelihood of disputes, and ultimately contribute to safer, more efficient, and financially stable construction project.
But what happens when disagreement arises and how can contracting parties protect themselves with better certainty? The answer is a liquidated damages clause.
In construction contracts, a liquidated damages clause specifies a predetermined amount of damages to be paid by the contractor to the owner in the event of project delays. This amount is typically calculated on a per-day basis. For example, a clause might stipulate a payment of $750 per day for each day the project exceeds the agreed-upon completion deadline. This arrangement offers several benefits to both parties:
Advantages of Liquidated Damages Clauses:
- Predictability and Certainty: Both the owner and the contractor are aware of the financial consequences of delays from the outset, enabling better risk assessment and contingency planning.
- Reduced Disputes: Liquidated damages clauses minimize disagreements and potential litigation over the exact amount of damages caused by delays.
- Simplified Compensation: Owners can recover losses without undergoing the complex and time-consuming process of calculating and proving actual damages.
- Faster Recovery: Owners can quickly assess and potentially deduct liquidated damages from payments owed to the contractor upon project completion.
- Risk Allocation: Liquidated damages clauses serve as a mechanism to apportion risk between the owner and the contractor, encouraging contractors to adhere to project timelines.
- Motivates Timely Completion: The possibility of owing liquidated damages incentivizes contractors to complete the project on schedule, promoting diligence and efficient project management.
Liquidated damages clauses can be advantageous for contractors because it transforms an unknown risk into a known risk, enabling contractors to price the risk more accurately and bid more efficiently on a project. Without a liquidated damages clause, a contractor faces uncertainty regarding the cost of potential delays, which can lead to higher bid prices to account for the unknown risk. By establishing a specific, predetermined amount of damages for delays, a liquidated damages clause allows contractors to better assess and allocate risk, potentially passing portions of it down to subcontractors.
However, certain conditions must be met for a liquidated damages clause to be enforceable:
- Reasonable Estimate: The stipulated amount must be a reasonable forecast of the potential losses the owner would incur due to delays, not an arbitrary figure or a penalty. Courts will examine the reasonableness of the amount at the time the contract was formed, comparing it to the anticipated damages. If the amount is found to be grossly disproportionate to the actual or potential harm, it may be deemed an unenforceable penalty.
- Difficulty in Estimating Actual Damages: Liquidated damages are typically favored when it is difficult to accurately estimate the actual damages that might arise from a breach at the time of contract formation. If actual damages are readily ascertainable, courts may scrutinize the clause more closely.
A carefully drafted and reasonable liquidated damages clause can be a valuable tool for managing risk and ensuring timely project completion in construction contracts. The attorneys at Simon PLC have decades of experience in drafting contracts of all types with a keen eye for the careful consideration of liquidated damages clauses.
N.B. Not Legal Advice: Please contact us if you would like to discuss the facts and circumstances of your specific matter. Simon PLC Attorneys & Counselors expressly disclaims all liability in respect to actions taken or not taken based on any or all the contents of this memorandum. The information contained herein may not reflect current legal developments and is provided without any knowledge as to the recipient’s location, industry, identity or specific circumstances. No recipients of this content, clients or otherwise, should act, or refrain from acting, on the basis of any content included in this memorandum without seeking the appropriate legal or other professional advice on the particular facts and circumstances at issue from an attorney licensed in the jurisdiction for which the recipient’s legal issue(s) involve. The application and impact of relevant laws varies from jurisdiction to jurisdiction, and our attorneys do not seek to practice law in states, territories and foreign countries where they are not properly authorized to do so.
