During construction and commissioning of large-scale energy projects, every day of delay or failure to meet plant performance requirements can result in the owner incurring substantial damages. Indeed, power industry owners can incur damages such as additional financing and administrative costs, in addition to lost operating revenues, if the plant cannot operate as scheduled. Because such damages can be difficult to prove, EPC contracts for power projects commonly provide for liquidated damages, which are a fixed sum contracting parties agree will be payable as damages for a specified breach. Negotiating for such damages can benefit owners because the damages resulting from a breach can be difficult to calculate. A liquidated damages clause allows the parties to avoid burdensome and potentially costly litigation regarding the amount of actual damages and provides certainty in the event of a breach.
Before agreeing to liquidated damages, however, owners should consider whether they would be better off seeking to recover their direct damages in the event of a breach. If a contractor will not agree to an amount of liquidated damages the owner believes would cover its actual, direct damages, it may be more advantageous to seek actual damages, as long as they could be proven without too much difficulty. Depending upon the circumstances and the parties’ respective bargaining power, a liquidated damages clause may not always be the best option.
Owners should consider the following issues when contracting for liquidated damages:
Ensure Liquidated Damages Will Cover Anticipated Losses
As noted above, an owner should carefully estimate its potential losses in the event of a breach and ensure the liquidated damages will cover these losses. At a minimum, liquidated damages should cover the cost of carrying the contract for the delayed period, including additional overhead, financing costs, and personnel costs. Because the contractor and owner must agree on the amount of liquidated damages, owners should be prepared to make their case to contractors for the amount they are seeking at the negotiating table. Having an upfront meeting of the minds as to the full extent of prospective damages an owner expects to incur in the event of a delay will help ensure that the contractor fully understands the risks and provides a realistic schedule and work plan.
Take Precautions to Prevent a Finding that Liquidated Damages Are a Penalty
Liquidated damages are intended to compensate the injured party for its losses, not to penalize the breaching party. Thus, as a general rule, most courts require that liquidated damages be a reasonable pre-estimate of the anticipated losses at the time of contracting. Some courts, however, also consider the actual losses sustained to determine whether liquidated damages are reasonable. And a few jurisdictions (such as Connecticut and Rhode Island) will not enforce liquidated damages clauses if the injured party cannot prove it has sustained at least some actual harm or damage, regardless of whether the liquidated damages were reasonable when viewed prospectively.
Courts will not enforce provisions for liquidated damages that are deemed to be a penalty, and owners can take precautions at the time of contracting to prevent liquidated damages from being held unenforceable on this basis. For example, an owner should internally document how it estimated its probable losses at the time of contracting. Owners should also exercise caution not to say anything a contactor could interpret as a threat that it will be penalized for a delay.
Because liquidated damages cannot be penal, some courts (including those in New York, Florida, and Illinois) have held that a contract may not contain a clause allowing an injured party to choose whether to seek recovery of its actual damages or liquidated damages (sometimes called an optional liquidated damages clause). These courts have stricken optional clauses and limited the plaintiff’s recovery to actual damages on the grounds that such clauses would penalize the breaching party and defeat the purpose of stipulating to liquidated damages. Notably, however, some jurisdictions have upheld such optional clauses, including Colorado, Idaho, and Washington. As the Colorado Supreme Court explained, parties have the freedom to contract for alternative remedies, as long as they do not pursue both. Owners may benefit from optional clauses in jurisdictions where they are enforceable.
Maximize the Scope of Covered Losses
While liquidated damages are generally used as a remedy for delay, liquidated damages clauses may also include performance elements. As long as the clause satisfies the operative requirements for enforceability, a contract may provide for liquidated damages if a contractor fails to timely complete work in accordance with specified performance criteria. For example, the parties may provide that if the contractor fails to deliver equipment in accordance with the contractual specifications and performance standards, it must pay liquidated damages for each day of delay. This would apply if the contractor delivers the equipment on time, but it fails to meet the required performance standards.
Most liquidated damages clauses provide for recovery of liquidated damages through the date of substantial completion because the project can be used for its intended purpose at that time. As one court explained, if the contractor fails to complete the outstanding work after substantial completion, the owner may hire someone else to finish and sue the contractor for its breach. Nevertheless, courts have allowed recovery of liquidated damages until final completion where the contract clearly reflects the parties’ intent to provide for such recovery. If an owner reasonably anticipates at the time of contracting that its losses will continue until final completion, or that it will not be able to operate and earn revenue until that time, it should attempt to provide for liquidated damages through that date.
Know When Damages Are Recoverable and What Law Applies
Owners should be mindful that they may not be able to recover liquidated damages for any period of concurrent delay, which occurs when the owner and contractor both cause a delay that impacts the same activity, each of which standing alone would have impacted the completion date. When both parties concurrently cause a delay, there is an old adage that a contractor may be entitled to “time but no money” because of the inherent difficulty in proving causation. While the law is unsettled, the modern trend is to apportion delay damages if there is sufficient evidence to determine the extent of the delay attributable to each party. Even under the modern rule, however, an owner may not recover delay damages if there is insufficient evidence to make this showing because the delay can be attributed to both parties’ simultaneous actions, or if the owner acted in bad faith, substantially contributed to the delay, or made it impossible for the contractor to complete its work. As a general rule, these principles apply regardless of whether there is a liquidated damages clause or the owner is seeking to recover its actual damages.
Finally, it is important to include a choice of law provision and be aware of the operative law. In most jurisdictions, the party seeking to recover liquidated damages must plead and prove the clause is valid, while the opposing party must show the absence of elements of the prima facie case and has the burden to prove the clause is an unenforceable penalty. But even though many courts apply the same general principles, some courts impose a higher standard to invalidate a liquidated damages clause. There is even a presumption of validity in some jurisdictions. And as noted above, some jurisdictions only require that liquidated damages be reasonable prospectively, while other courts also consider the actual losses sustained. While no one wants to contemplate disputes regarding delay damages at the time of contracting, owners can benefit if the contract is governed by a state’s law that tends to uphold liquidated damages and imposes a heavy burden on a party seeking to invalidate them.