By Michael C. Loulakis and Lauren P. McLaughlin
Because clauses related to liquidated damages, known as LDs, are so common in construction contracts, many people have come to assume that if the parties agreed to them in the contract, the LD clause must be enforceable. That is not always a correct assumption. The longstanding principle of LDs is that they must bear a reasonable relationship to the actual damages expected to be incurred by the party who will collect them. Stated differently, if an owner has the right to recover LDs for the late performance of a contractor, the owner must demonstrate that its LD formula and amount reasonably correlate to the costs it expected to incur from not having the facility available to it by the specified contract date.
Most of the reported case law on schedule-related LDs addresses disputes over excusable delays, such as whether the contractor was entitled to a time extension that would mitigate some or all damages. However, every now and then there is a case discussing the validity of the LD formula and amount. This issue’s case, Appeal of Sauer Inc., does just that.
The U.S. Army Corps of Engineers awarded a $33 million design-build task order to Sauer Inc. for work associated with the construction of the new 82nd Airborne Division headquarters building in Fort Bragg, North Carolina. The task order divided the work into three phases: construction of the new building; furniture installation and the move into the new building from the existing headquarters; and demolition of the existing headquarters building and construction of a parking lot for the new building.
Each phase had a specific date by which it was to be completed, and the overall project was to be completed in 700 days. The task order specified LDs of $4,365.81 for each day beyond the deadline if the project was not completed on time.
Sauer finished the first two phases on time but was 33 days late in finishing the third phase. The Corps assessed LDs against Sauer for that delay in the amount of approximately $144,000. Sauer argued that this was inappropriate because the Corps had been able to occupy the new headquarters four months before the overall contract’s completion date. It noted that the work associated with the new building (i.e., the first phase) represented 98.7% of the total construction-related costs and that phases 2 and 3 involved only minor work that did not affect the Corps’ “beneficial occupancy” of its new headquarters.
The Corps rejected Sauer’s position, primarily on the grounds that the LD provision was tied to completion of all three phases, not just the first phase. This prompted Sauer to appeal to the Armed Services Board of Contract Appeals.
Sauer filed a motion for summary judgment, arguing that there were no material facts in dispute as to its claim that the LDs should not have been assessed. In a rather lengthy and well-reasoned decision, the ASBCA largely agreed with Sauer’s position.
The ASBCA referred to the principle that it was improper for the federal government to assess LDs after the date of substantial completion and that the government had the burden of not only establishing the date of substantial completion but also whether the period of time for which the government assessed the LDs was correct. It also noted that the terms “substantial completion” and “beneficial occupancy” are used interchangeably and that “beneficial occupancy” is associated with the owner using a facility prior to the completion of the contract. Given this, the first question the ASBCA evaluated was whether Sauer had substantially completed the project late so as to justify the LDs.
In deciding this question, the ASBCA noted that the Corps’ original request for proposals did not divide the project into phases but instead had a single completion date for all work. The RFP was eventually revised to create the three phases. The Corps argued that by doing so, “the parties agreed that each phase would have functionally equivalent importance regarding performance” and that it was appropriate to have LDs tied to completion of the entire project.
The ASBCA rejected this argument. It found that simply dividing a contract into phases, without anything more, does not establish the functional equivalence or importance of each phase. The Corps offered “no evidence supporting a finding that completion of phase III was functionally equivalent to completion of phase I or, for that matter, phase II.”
The ASBCA ruling stated:
“Other than its bare allegation that the existence of a phased contract establishes the singular import of each phase, the government offers no evidence that strict compliance to completion of all three phases truly was ‘essential.’ The task order provisions cited by the government do not speak to the parties’ expectations regarding the owner’s reasonable use of the facility, or whether the project was capable of adequately serving its intended purpose at the time the government claimed the right to assess liquidated damages.”
Based on this, the ASBCA concluded that phases 1 and 2 were substantially completed on time and not subject to LDs. The ASBCA was unable to make a summary judgment determination on whether the third phase was substantially completed on time and concluded that more facts were needed to sort this out.
The ASBCA then turned to the issue of how to address the assessment of LDs, given that the Corps had only established one daily rate for the entire project as opposed to individual LD amounts for each phase, as would normally be expected. The Corps argued that the full $4,365.81 daily rate was appropriate, and Sauer argued that this rate was unreasonable relative to delays to phase 3.
The ASBCA agreed with Sauer, stating: “The government’s assessment of the full amount of daily liquidated damages after substantial completion and acceptance of the first two phases is unenforceable.” Consequently, it said, if the third phase was not substantially completed on time, the Corps would be entitled to “some measure of apportioned liquidated damages.” The amount of the apportioned LDs would ultimately be subject to the evidence produced at trial.
Two elements to this decision are particularly interesting. First, most owners know that when using distinct phases or milestones, they need to have separate LDs for each phase/milestone, particularly when there are discrete completion dates in the contract for them. The root cause of the dispute in this case was that the Corps failed to do this. It is hard to imagine that the owner’s expected costs from late completion delaying its move to a new building would be the same as those arising from a delay in the contractor finishing the demolition of an old building and construction of a new parking lot. The ASBCA cited longstanding principles that the owner has the duty to demonstrate the reasonableness of its LD rate, and with the small amount of work associated with the third phase in this case, the Corps could clearly not use the full rate.
Secondly, Sauer and the ASBCA argued that the LD amount should be apportioned (i.e., reduced) for phase 3 delays. This is not what we would have expected. Schedule LDs reflect an agreed-upon amount of damages for delay. In this contract, there was no contractual agreement between the Corps and Sauer as to what the daily rate would be for delays to phase 3. As a result, we would have expected the LD clause to be rejected outright as being unreasonable, with the Corps having to then prove its actual damages.
While the parties could always have agreed during the contract as to what an appropriate rate should be, they did not. While we are almost sure this case will settle, it would be interesting to find out how the ASBCA would ultimately handle this question.
Michael C. Loulakis ([email protected] cp-strategies.com) is the president and CEO of Capital Project Strategies LLC, in Reston, Virginia. Lauren P. McLaughlin ([email protected]) is a partner of Smith, Currie & Hancock LLP, in Tysons, Virginia.
This article first appeared in the January/February 2022 issue of Civil Engineering.