By: Alexander A. Miuccio Published: December 2014

Court Rules Penalty Provision Against Contractor is Unenforceable

Many large construction contracts contain a liquidated or stipulated damages provision which provides a specific dollar amount to be assessed for each day of delay in the completion of the project. A liquidated damages clause may be included in prime contracts, subcontracts and material supply contracts.

Courts, however, will not enforce a liquidated damages provision where the agreed upon amount is grossly disproportionate to the actual damages resulting from the delay. Whether the provision is a valid liquidated damages provision or an unenforceable penalty is sometimes difficult to determine.

In the recent case of Phoenix Construction, Inc. v 70th Street Apartments Corp., the court addressed the enforceability of a clause providing for $250 to be assessed for each calendar day of delay.

Background

Phoenix was retained by 70th Street Apartments to perform certain specified roofing and façade work. The contract provided that if the work was not fully completed within 120 days, “then a penalty equaling Two Hundred Fifty Dollars ($250.00) per calendar day will be imposed upon the contractor”. The contractor completed the work in 302 calendar days—182 days late.

The contractor was not paid the full amount of its work and filed a mechanic’s lien against the premises for $46,285.35 to secure its payment. The contractor thereafter started a lien foreclosure action. In response, the owner attempted to offset the amount owed by asserting a counterclaim seeking $45,500, which is the stipulated $250 daily amount assessed for each of the 182 days of delay.

The owner moved for summary judgment to discharge the contractor’s mechanic’s lien, dismiss its lien foreclosure action, and also to enforce the penalty provision based on the contractor’s delayed performance. In support of its motion, and in order to demonstrate that the contractor did not complete the job until well after the time frame set forth in the contract, the owner submitted a final waiver of lien and release of claims executed by the contractor after the 302nd day of the project. The contractor opposed the owner’s motion, arguing that the delays were the owner’s fault, and that the provision—which was clearly labeled as a “penalty”—was unenforceable because the stipulated damages claimed did not rationally relate to the actual damages resulting from the delay. The contractor claimed that there were no extra costs incurred by the owner as a result of the delay because the architect, who oversaw and supervised the job, was paid on a flat-rate basis and, therefore, the owner would not have been liable for additional compensation to the architect for its extended supervision time. The contractor also noted that the owner submitted no evidence of other delay costs to justify the imposition of the stipulated amount of delay damages, but was simply relying on the fact that the project was completed late.

Decision

The court recognized that liquidated damages clauses are enforceable where the amount stipulated is a reasonable measure of the actual delay damages anticipated. The court ruled, however, that the provision here was an unenforceable penalty clause and not a valid liquidated damages provision. The owner even referred to the provision as one of a “penalty”. The court also pointed out that the contractual clause itself provides the term “penalty”.

The court also noted that the owner failed to offer any evidence of actual damages which would approximate or reasonably relate to the amount stipulated in the contract. Accordingly, the court dismissed the owner’s counterclaim, holding that such penalties are not enforceable and contrary to public policy. However, the contractor did not fare well either. The contractor’s claims were dismissed in light of the final waiver of lien and release of claims it signed and submitted to the owner.

Comment

Contractors who seek to include liquidated damages provisions in their downstream contracts would be well advised to attempt to reasonably forecast the measure of damages they would sustain in the event of an actual delay. The computation does not need scientific precision; it will be upheld so long it is “a reasonable measure of the anticipated probable harm”. If, however, the provision is inserted as a scare tactic to ensure timely performance or to impose punishment for late completion regardless of actual damage, it will be unenforceable.

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