enforceable liquidated damages clauses

By: adrienne isacoff, esq., florio, perrucci, steinhardt, cappelli, Tipton & Taylor LLC

Liquidated damages clauses are a staple of public and commercial contracts. It is useful for contractors to understand when such clauses are enforceable, at all stages of contract performance – from bid review to litigating claims.

Liquidated Damages in Bid Specifications

On the State level, New Jersey Department of Transportation, Standard Specifications, Section 108.02, provides a properly worded liquidated damages clause, in which the contractor and the Department recognize that delays to the contract time may result in damages to the Department, for which liquidated damages may be imposed as compensation for actual damages, and not as a penalty. Most county and municipal highway and road construction contracts directly incorporate the Standard Specifications into their contract or otherwise use comparable language to impose liquidated damages for delay beyond substantial completion.

The amount of liquidated damages that may be imposed must be specified in both the bid documents and the contract so that bidders are able to prepare their bids with the risk of delay calculated into their estimate. The Local Public Contracts Law, N.J.S.A. 40A:11-1 et seq., does not directly address the circumstances under which liquidated damages may be enforceable. But New Jersey case law has interpreted the requirement that “[a]ny specifications for the provision or performance of goods or services under this act shall be drafted in a manner to encourage free, open and competitive bidding (N.J.S.A. 40A:11-13) to require specifications that are unmistakably clear, because ambiguous terms “may seriously affect the purpose of competitive bidding.”

Pucillo v. New Milford, 73 N.J. 349, 355 (1977); see, also, Saturn Constr. Co., Inc. v. Bd. of Chosen Freeholders, Middlesex Cty., 181 N.J. Super. 401 (App. Div. 1981).

Liquidated Damages Must Be a Reasonable Forecast of Just Compensation

Courts in both New Jersey and other jurisdictions have consistently held that the amount of daily liquidated damages imposed by a contract must be a reasonable forecast of just compensation for any delay caused by failure to timely complete the project. The rule was stated in the following terms in Westmount Country Club v. Kameny, 82 N.J. Super. 200, (App.Div.1964), as follows:

An agreement made in advance of breach, fixing the damages therefor, is not enforceable as a contract and does not affect the damages recoverable for the breach, unless (a) the amount so fixed is a reasonable forecast of just compensation for the harm that is caused by the breach, and (b) the harm that is caused by the breach is one that is incapable or very difficult of accurate estimate. Upon a consideration of the whole agreement, if it is doubtful whether the provision for payment is intended as a penalty or liquidated damages, it will be construed as a penalty, because the law favors mere indemnity.

In Utica Mutual Insurance Co. v. DiDonato, N.J. Department of the Treasury, 187 N.J. Super. 30 (App. Div. 1982), the court noted that in interpreting and applying a liquidated damage clause, more than a mechanical multiplication of the number of days delay by the perceived contract amount is required. There must be a preliminary inquiry to determine whether the contract clause provides for the imposition of a penalty or the assessment of liquidated damages. The Appellate Division further emphasized that an owner has the burden of proof in establishing that the liquidated damages were reasonable, as well as in proving that any delay by the contractor was not excusable. The Appellate Division remanded the case because, among other things, the trial court did not make specific findings that the liquidated damages were reasonable.

See, also, D.A. Nolt, Inc. v. The Philadelphia Municipal Authority, 463 F.Supp.3d 539 (E.D. Pa. 2020), in which the court denied enforcement of a $10,000/day liquidated damages clause, holding that the provision was not based on a reasonable forecast of probable costs.

There are occasions where a public owner drafts bid documents that are not in accordance with these general principals. If the bid specifications simply provide that “the Contractor shall pay the Owner liquidated damages for the above-stated actual costs incurred,” bidders may be able to successfully challenge those specifications, since they are not being informed of the daily rate in advance of any contract dispute. Such a poorly drafted provision does not conform to the court mandate that the specifications allow bidders to prepare their estimates with a full understanding of the contract terms and risks involved. In addition, a provision written in this fashion fails to meet the requirement that owners make a determination prior to drafting the contract of a reasonable forecast of actual damages for delay.

Liquidated and Actual Damages

Contractors should remain mindful that actual damages for breach of contract other than those caused by delay may be imposed in addition to liquidated damages. However, most jurisdictions hold that an owner may not be entitled to both liquidated damages and actual damages for delay. For example, in U.S. Fidelity & Guar. Co. v. Braspetro Oil, 369 F3rd 34, 73 (2d Cir. 2002) the court held that, “Under no circumstances, however, will liquidated damages be allowed where the contractual language and attendant circumstances show that the contract provides for the full recovery of actual damages, because liquidated and actual damages are mutually exclusive remedies under New York law. See also Fed. Realty Ltd. P'ship v. Choices Women's Med. Ctr., 289 A.D.2d 439, 441, 735 N.Y.S.2d 159 (2d Dep't 2001).

As explained by the court in Glob. Facility Mgmt. & Constr., Inc. v. Joe & the Juice Miami LLC, 2019 WL 2237976, at *2 (Sup. Ct. Suff. Cty. 2019), where the parties’ agreement contains both liquidated-damage and actual-damage provisions, “[s]uch a scheme cannot be read to reflect a good-faith effort by the parties to liquidate their damages” and, therefore, under New York law, “it is the liquidated-damage provision, and not the actual-damage provision, that is unenforceable”.

Best Practices

Bidders should carefully review bid specifications to review the wording of any liquidated damages clause. If the provision does not provide for a reasonable daily assessment for delay, and/or if it allows the owner to assess both liquidated damages and actual damages for delay, the bidder may want to challenge the bid specifications pre-bid in accordance with the time requirements set forth by applicable law. If a contractor is assessed liquidated damages for asserted failure to timely perform the project, the contractor should require the owner to prove that there was no excuse for delay and that the amount of liquidated damages assessed was reasonable.