Of all the reasons I come across for non-payment when running building industry payment claims, liquidated damages is by far the most common. This is a concept which promotes destructive behavior and should be scrapped.
I have never understood the point of liquidated damages. Contractually, they are there to compensate a party for its genuine pre-estimate of costs incurred due to the other party completing work late as the delay will, so the story goes, cause damage for which the party should be compensated.
Even if you accept this rationale, however, severe problems remain with these types of claims, which often lead to acrimonious battles over who is to blame and alleged costs involved as developers seek to use such claims to withhold final payments to builders and builders do likewise to subcontractors.
Moreover, the aforementioned rationale misses two important points.
First, construction projects are the combined efforts of many parties who to an extent are interconnected and depend on one another. This means delays in one part of the chain impact the ability of others to complete their work and makes any objective assessment regarding fair apportionment of fault for missed deadlines almost impossible.
Consider the case of a mechanical services contractor installing ventilation ducts who arrives on the job and finds he or she cannot install to plan because the plumbers had already installed the fire sprinkler pipes which were in the way.
As a result, they need to rework them to run around the pipes, slowing them down. Further, consider what happens where the sheet metal contractor who redesigns and fabricates the new ducts finds these have to be subsequently redesigned again because design consultant errors mean drawings they were working from were inaccurate. Fast forward three months and the work is late, but who is responsible and to what extent? Responsibility certainly cannot fall on any one contractor individually, yet the builder seeks to recover money from the contractor and everyone is arguing and pointing fingers. What a mess.
This brings me to the second point. Rather than promoting productivity, liquidated damages actually reward conflict and encourage contractors to manage each other through fear and achieve outcomes through punishment. It punishes individual parties for something that is usually not entirely their own fault but rather a collective failure stemming from poor planning and cumulative errors which build on and compound each other.
There is a better way. One based on reward rather than fear. One based on positive motivation and encouragement.
Instead of punishing contractors for ‘liquidated damages’, why not instead reward them with ‘liquidated bonuses’? Such a bonus could be based on a genuine pre-estimate of savings made by the principal if the project is delivered on time, with such bonuses being shared down the line from the head contractor to the water proofer and landscaper. For example, a developer might put up the first two months’ rent on a block of units as an on-time bonus, using this as an alternative to fighting for six months of liquidated damages.
This has worked before. Soon after taking over Continental Airlines in the early 1990s, for example, Gordon Bethune instigated a system whereby everyone from ground crews to pilots received a bonus of the same amount for every month Department of Transport figures rated the airline number one for on time departures. The result: within 18 months, the airline went from being literally the worst in the US to being the best – something which surely would not have been achieved under a system of blame and docked pay for late departures.
Moreover, such a system would have additional benefits in that parties would probably be more open, honest and realistic about how long work is really going to take and would be more inclined to work in a co-operative manner.
There is enough conflict in building projects already. Why cling to a system that rewards destructive behaviour?