Why Liquidated Damages Should Be Abolished 12

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Friday, May 23rd, 2014
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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?

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Discussions
12
  1. Dave Kubler

    In my experience, liquidated damages protect a key tenant who expects/requires a fixed "opening" date for their new store. Any late delivery of a project which pushes out this opening date will incur significant cost/loss of tenant income.

    When looking at a large box retailer, this can be $100K+ a week, I don't see how this can be reverse engineered into a construction project as a liquidated bonus at the start.

    The tenant needs guaranteed income, either through the store opening on time or from reclaimed costs to cover their investment.

  2. John Falkner

    Sounds right on to me. Building should be about people working cooperatively, not being at war with each other. Anything that can make this happen should be welcome.

  3. John Tozer

    And what makes Anthony think there won't be just as many acrimonious fights about which trade it was that under-performed and prevented the others from accessing their 'liqudated bonus'?

  4. Richard Booth

    So Anthony what do you suggest should be done about the contractor (or sub-contractor) that decides because they have made a better bargain on another project that they will starve your project of resources to ensure they maximize their gain on that deal, with the effect of causing your project to run late? Do we have to then go to court for relief because there are no LD's – which only feeds the legal profession? LD's have always been a workable deterrent – whether you actually apply them or not – so leave them be.

  5. Gordon Lee

    If you argument is right, why the contractor should claim for delay cost by the developer or some reasons not foreseeable and punish the developer in such the way similar to liquidated damages.

  6. Simon Guthrie

    Seldom have I read a more well reasoned argument for the abolition of the major cause of the destruction of viability of SME's in the construction industry. Subcontractor payments despite the best efforts of the various security of payments regimes are constantly under threat by major construction companies imposing impossible deadlines from an estimating staff very far from the coal face. The "claw-back" is endemic in the Australian construction sector.

  7. Luke Anglicas

    Bonuses for early achievement of PC and early entry of tenants ("liquidated bonuses") has been done on many projects and only causes the same arguments regarding achievement of PC, completion of defects, tenants not being ready to move in early or not wanting to pay rent early because they are still paying in their current premises.
    Builders try to take short cuts to get the bonus and developers fight to prove the bonus has not been earned. It then gets worse between contractor and subcontractor when the blame game starts as to "who caused us to lose our bonus."

    Its probably even worse than LD's. Contracts will always be documents for protection, collaboration is really more of a attitude or personal inventory.

  8. David Chandler

    Anthony is right. LDs in the context of construction today is simply a farce often in the wrong hands. Large contractors see it as a one way street to beat up the supply chain and run from when the disruption is of their making. Construction productivity will only be improved when the marriage of off-site and on-site is made. Off-site is not just the manufacturing discussion its one that looks at everything that happens before a job starts on-site. The current procurement model does not suit the step change needed. Its time to ban bid-shopping. I have seen this work well in North America. Its also time to introduce electronic payments across the supply chain. These initiatives will do more to synthesis construction than anything else.

  9. Roo

    Fair point, however the LD's mechanism if more often passed to the builder by the client. In turn, the client is most likely subject to LD's with their client and so on.

    Unless the end user accepts ultimate risk of delay I can’t see LD's leaving the mainstream, which is a shame.

  10. Richard Altavilla

    Whilst I personally don't agree with LD. BIM is making it possible to provide sufficient information to all involved in the AEC industry to provide a very good simulation of time and costs in the development. As such it would most certainly minimise potential blow outs that might incur.

    Having said that if LD is going to be imposed then also bonuses should be implemented if the project runs to time and budget.

  11. David Saddington

    Congratulations for putting such a good concept forward. Liquidated damages only pits developer against builder against subby. And when it goes to court the only winners are the lawyers.

  12. Peer Afridi

    I support John Falner . A contractual agreement with embodying philosophy of punishment and reward should go hand in hand and should be mutually acceptable to both the parties to the construction contract. Any effort on the part of any one to exploit the incentives on rewards like Early Completion Bonus Or penalty on delayed completion like LDs, routinely stipulated in the contract documents, should be discouraged.