Courts will enforce an assessment of liquidated damages if the amount of those damages was reasonable at the time the contract was signed. Courts will not enforce liquidated damages when the amount of damages specified is unreasonable and is, therefore, a penalty. Also, courts will not enforce liquidated damages when the owner or third party for whom the contractor is not responsible is solely or concurrently responsible for the delay.
A. Provisions for liquidated damages will be enforced if they are reasonable at the time of contracting.
In Washington, a provision for liquidated damages will be upheld unless it constitutes a penalty or is otherwise unlawful. Washington courts favor the enforcement of liquidated damages provisions under general principles of contract law. As stated by both the Washington and United States Supreme Court, liquidated damages agreements fairly and understandingly entered into by experienced, equal parties with a view to just compensation for the anticipated loss should be enforced.
In rationalizing its favorable view, courts have listed several advantages to enforcing liquidated damages provisions. For example, such provisions may facilitate the calculation of risk and reduce the calculation cost of proof for the parties; injured parties will benefit by being afforded the only possibility of compensation for loss that is not susceptible of proof with sufficient certainty; and judicial time and resources will be preserved because liquidated damages may cut the expense of litigation.
Courts apply a two-part test, as of the time the contract was entered into, to determine whether to enforce a liquidated damages clause. Applying the two-part test, a liquidated damages clause is valid if (1) the amount fixed is a reasonable forecast of just compensation for harm caused by the breach, and (2) the harm is difficult to ascertain. Stated more succinctly, the central question is whether the specified liquidated damages were reasonable at the time of contract formation. The greater the prospective difficulty of estimating possible damages, the greater the range of reasonableness used in assessing a liquidated damages provision.
Actual damages are irrelevant except for as evidence of the reasonableness of the liquidated damages estimate at the time of the contract formation. Additionally, actual damages may be considered where they are so disproportionate to the estimate that to enforce the estimate would be unconscionable.
B. Liquidated damages will NOT be enforced if construed as a penalty.
Courts will not enforce liquidated damages when the provision amounts to a penalty, which is a contract provision that “bears no reasonable relation to actual damages.” Penalties further involve an independent element of punishment, irrespective of the damage sustained, whereas “the essence of liquidated damages is a genuine covenanted pre-estimate of damages.”
Walter Implement v. Focht provides an example of when the court will refuse to enforce a liquidated damages provision on the basis of it being a penalty. In that case, involving an agreement to lease farm equipment, the liquidated damages clause required the breaching lessee to pay 20 percent of the outstanding rental payments at the time of the breach. Thus, the liquidated damages could vary from $2,161.26 for a default in the fourth year to $8,645.06 for a default in the first year. The Supreme Court of Washington reasoned that because the amount of liquidated damages was not fixed, but varied dependent upon when the default occurred, the amount of damages could not be reasonably related to the anticipated harm. Without an explanation of how the variation reflected a reasonable forecast of the harm caused by the breach, the Court found the liquidated damages provision to be an unenforceable penalty.
Based on the Court’s reasoning in Walter Implement, contractors can make at least two arguments that a liquidated damages assessment is an unenforceable penalty. First, the assessment could be a penalty for being grossly disproportionate to the actual damages. And second, the assessment is not a fixed term, but is instead dependent on a variable that is not related to the anticipated harm.
C. Generally, liquidated damages will not be enforced when the owner is solely or concurrently at fault for the delay, unless there is proof of each party’s respective fault.
It is settled law that liquidated damages may not be assessed for delays in the completion of a construction project that are attributable to the owner or a third party the contractor is not responsible for, or that are otherwise excusable, such as force majeure. Furthermore, in the context of concurrent delay, Washington courts follow the general rule that a party to a contract cannot recover liquidated damages for a breach to which he has contributed and there can be no apportionment of liquidated damages when both parties are at fault. The reason for this rule is that it may be too difficult to delineate fault.
In fact, the City of Seattle has included a provision in some of its construction contracts to eliminate liquidated damages when there is a concurrent delay. The paragraph regarding concurrent delay in a recent City contract states:
Concurrent delays are those delays where progress on critical path activities is impeded over the same period of time due to causes attributable to both the Contractor, and Engineer or Owner. In the event of a concurrent delay, neither party shall be entitled to compensation from the other, over the period of time that concurrency of delay exists.
But despite the general rule to prohibit liquidated damages in the event of concurrent delay, there are situations where the courts will find apportionment of liquidated damages proper. Such situations arise when actual damages are difficult to prove and the jury was presented with an adequate basis for allocating the contractual measure of damages to the respective parties. For example, in Baldwin v. Nat’l Safe Depository Corp., a case involving the breach of a lease for the use of four signs, the lessor was found to have breached the lease regarding three of the signs, while the lessee was found to have breached the lease regarding only one. Because the jury was presented with unrefuted evidence of the monthly rental for each of the four signs, the jury was permitted to allocate the liquidated damages accordingly. Thus, the lessor was entitled to only a portion (¼) of the liquidated damages.
Courts have apportioned liquidated damages against multiple contractors in construction disputes too. In Alcan Electrical & Engineering Co., Inc. v. Samaritan Hosp., an unpublished decision, the court relied on credible evidence to determine that one subcontractor was responsible for 170 days of the delay on the project, while another subcontractor was responsible for only 31 days of the delay. The court then apportioned the liquidated damages accordingly, based on the amount of the delay attributable to each subcontractor.
Here, the key takeaway is that the apportionment of damages is appropriate only when there is persuasive evidence of each party’s respective fault. Without such evidence, a liquidated damages clause will be unenforceable when both parties concurrently breached the contract.