The phrase “Time is of the Essence” can be found in most construction contracts today, but what does it mean? The Ohio Supreme Court has weighed-in on this issue with a very specific definition. In Lake Ridge Academy v. Carney (1993), 66 Ohio St.3d 376, the court held that “the proper meaning of the phrase is that the performance by one party at the time specified in the contract or within the period specified in the contract is essential in order to enable him to require performance from the other party.”

In the construction setting, this simply means that the completion date is a very important term in your contract. When the contractor does not finish on time, there are a number of remedies that, according to the owner-contractor agreement, may be available to the owner, including consequential damages and liquidated damages.

Consequential damages are damages that are not directly caused by a delay. An example would be loss of rental income, loss of business reputation, etc. While these can be very real damages to a business, they can often be quite difficult to calculate.

In addition, consequential damages may not be envisioned by both parties (i.e., the owner and the contractor) at the time the contract is created. This is important because while Ohio courts do allow for the award of consequential damages, they require that the damages be foreseeable by the parties at the time the contract is entered into.

This can be seen in Smoot v. State of Ohio (2000), 136 Ohio App.3d 166. There, a contractor claimed that delays by the owner on one construction project caused damages to the contractor on a separate project. In denying an award of consequential damages to the contractor, the Ohio Supreme Court held that “in order to recover consequential damages suffered on an unrelated contract, the [contractor] must show that, at the time of entering into the primary contract, the [owner] had reason to foresee that a breach of the primary contract could cause the [contractor] to suffer damages on a second unrelated contract.”

In that particular instance, the court found that there was no evidence presented to show that the owner had reason to know that delays on its project would impact the contractor on the other construction project. The Smoot case illustrates an instance of a contractor seeking consequential damages from an owner.

The AIA (American Institute of Architects) contract documents, used on many construction projects, have taken a different approach altogether with regard to consequential damages in certain of its documents. Beginning with the 1997 edition of the AIA documents, the AIA added a mutual waiver of consequential damages by both the owner and the contractor to the general conditions document. The 1997 General Conditions document states:

4.3.10 Claims for Consequential Damages. The Contractor and Owner waive Claims against each other for consequential damages arising out of or relating to this Contract. This mutual waiver includes:

.1 damages incurred by the Owner for rental expenses, for losses of use, income, profit, financing, business and reputation, and for loss of management or employee productivity or of the services of such persons; and

.2 damages incurred by the Contractor for principal office expenses including the compensation of personnel stationed there, for losses of financing, business and reputation, and for loss of profit except anticipated profit arising directly from the Work.

This mutual waiver is applicable, without limitation, to all consequential damages due to either party’s termination in accordance with Article 14. Nothing contained in this Section 4.3.10 shall be deemed to preclude an award of liquidated direct damages, when applicable, in accordance with the requirements of the Contract Documents.

As a result, both parties may agree to abandon their right to such indirect damages. This mutual waiver was also included in the 1997 version of the owner-architect agreement (AIA Document B141-1997); it has been retained, to the disdain of many owners and contractors, in the recently revised AIA Document A201-2007 (General Conditions) and new versions of the owner-architect agreement.

Some owners feel that the mutual waiver is unfair because they believe consequential damages to owners, such as lost rents, dwarf comparable consequential damages to contractors, such as a contractor’s lost home office overhead. The AIA, however, chose to maintain the mutual waiver based on the belief that consequential damages could lead to large, complex claims that were generally uninsurable by the parties.

With consequential damages off the table, liquidated damages provide an alternative time related remedy for owners. Liquidated damages are a predetermined amount set forth in the contract by which the contractor will compensate the owner in the event the work is not completed on time. This is typically a per diem amount the contractor will pay the owner if the project is not completed by a set end date.

Unless provided otherwise by law, liquidated damages are typically required on public works projects in Ohio according to Ohio Revised Code § 153.19. The AIA contract documents do not include a specific provision for liquidated damages, but they do include a blank space on the form agreements where parties may insert a liquidated damages amount.

While parties are generally free to determine the terms of their contracts (including liquidated damage amounts), courts do review liquidated damage provisions with a closer degree of scrutiny. In particular, courts look for whether liquidated damage amounts cross over from being fair compensation for a breach of contract to an impermissible penalty.

Courts employ a three-part test for evaluating if a liquidated damage clause constitutes an impermissible penalty:

1. Are the actual damages uncertain and difficult to prove at the time the parties entered into the contract?

2. Is the contract as a whole manifestly unconscionable, unreasonable, and disproportionate?

3. Is the contract consistent with the conclusion that the parties envisioned such damages in the event of a breach?

Most court cases dealing with the issue of liquidated damages present a scenario where the liquidated damage amount specified in the contract is unreasonably high. In Samson Sales v. Honeywell (1984), 12 Ohio St.3d 27, the court encountered just the opposite. There, Honeywell provided an alarm system to Samson under a contract that included a $50 liquidated damage clause given a breach.

When Samson’s business was burglarized, the Honeywell system failed to activate, resulting in over $68,000 in stolen goods and merchandise. Honeywell, in an attempt to minimize its liability, pointed to the liquidated damage provision of the contract and argued that their maximum liability was $50.

In following the three-part analysis above, the court found that Samson’s earlier actions of spending $10,000 on an alarm system was inconsistent with the conclusion of a $50 recovery given the failure of the alarm system to perform. On these grounds, the court rejected the liquidated damage provision as an impermissible penalty.

Consequential damages and liquidated damages are but two of the various remedies available to an owner when the project is not completed by the scheduled completion date. “Time is of the Essence” can have significant monetary impacts on the contractor if the contract includes consequential damages and/or liquidated damages. Whether you are an owner or a contractor, you should review these and other contract provisions with your construction attorney.