When entering into contracts with contractors, you need to consider the potential financial implications if the contractor fails to complete the works on time. Building contracts usually contain provisions for liquidated damages for late completion payable by the contractor at a set rate. The benefit of this is that the employer does not have to prove loss arising from the delay but can simply claim or deduct the damages at the agreed rate.
However there is also a benefit for the contractor. Liquidated damages operate as a cap on the contractor's liability for late completion. So if your actual loss exceeds the amount of the liquidated damages, the additional loss cannot usually be recovered. Contractors usually insist on having liquidated damages provisions in order avoid the risk of larger losses.
You therefore need to give careful thought, before entering into the contract, as to what the potential losses/costs could be if completion is delayed. These might include:
- Loss of rent;
- Impact on other areas of the building;
- Additional financing cost.
Where potential losses are not clear at the outset, there may be a temptation to set a high liquidated damages figure. However this could have adverse implications. If the rate is too high, there is a risk that it could be challenged in the courts as a penalty and therefore be unenforceable, although this is rare. More often, when faced with a high level of liquidated damages, contractors will price in an allowance for the liquidated damages they might have to pay, or even, in more extreme cases, they may decline to tender for the work.
It is therefore essential that sufficient care is taken before contracts are entered into to fully assess the potential costs of delays by the contractor while resisting the temptation to over-estimate them.