Foreseeing the Future: The Importance of Liquidated Damages Amidst Supply Chain Disruptions

By Mark McCallum posted 05-09-2022 12:56 PM

  

By Christian Fernandez and Creighton Dixon of Snell & Wilmer LLP
Published Spring 2022

Construction contract provisions concerning liquidated damages and construction delays are important to consider together. Through a liquidated damages provision, contracting parties agree in advance to the amount of losses or damages the non-breaching party will suffer in the event of a breach. Liquidated damages provisions are typically utilized for construction delays because damages resulting from a delay are hard to define or calculate, thus providing the parties with increased certainty in the event of a breach. Owners typically include liquidated damages clauses in construction contracts to recoup losses that the owner may incur as a result of a project not being completed as scheduled.

Recently, the interplay between liquidated damages provisions and breach of contract claims arising from construction delays has received increased focus because of unpredictable supply chain disruptions that have plagued the industry globally. Depending on their project’s contractual terms, contractors and subcontractors may be liable for schedule delays caused by supply chain disruptions that delay construction materials and supplies. Therefore, contractors and subcontractors should carefully consider the consequences of the liquidated damages provisions in their contracts and whether the provision can be triggered by a material and supply delay that is out of that parties’ control.

If a contracting party, usually the owner, wishes to include a liquidated damages provision for an Arizona contract, it must not be a penalty for a breach. To determine whether a liquidated damages provision is reasonable and not simply a penalty, courts consider “(1) the anticipated or actual loss caused by the breach, and (2) the difficulty of proof of loss.”[1] Therefore, liquidated damages may be reasonable if the amount approximates the “loss anticipated at the time of contract creation (despite any actual loss) or the loss that actually resulted (despite what the parties might have anticipated in other circumstances).”[2] Because a court may inquire as to whether the amount of liquidated damages were a reasonable approximation of losses anticipated at the time of contracting, it is important for the owner to document and retain proof as to how the liquidated damages amount was calculated and why the amount was a reasonable approximation of anticipated losses. Such evidence will aid in the enforceability of a liquidated damages provision.

In contrast, contractors or subcontractors who wish to avoid liquidated damages liability resulting from supply chain delays should consider negotiating to exclude material and supply delays from triggering a breach that results in liquidated damages, such as by providing an excusable delay or other extension of time.

In conclusion, owners, contractors and subcontractors should carefully consider how to include a liquidated damages provision in their contracts, and, if so, whether the provisions will be triggered by material and supply delays.

 

[1] Dobson Bay Club II DD, LLC v. La Sonrisa de Siena, LLC, 242 Ariz. 108, 111 (2017).

[2] Id. 



Christian Fernandez is an Associate with Snell & Wilmer and a member of the firm’s commercial litigation practice group. His experience includes performing legal research and drafting memorandums, briefs and motions on a wide range of commercial litigation topics such as contract disputes, construction law, consumer protection matters, and tortious interference with business relations. He can be reached at cfernandez@swlaw.com or 602.382.6939.

 

Creighton Dixon is an Associate with Snell & Wilmer. He primarily advises clients in three areas: construction law, water law, and commercial litigation. His construction practice includes advising owners and contractors as it relates to contract negotiations, licensing concerns with Arizona’s Registrar of Contractors (ROC), the Prompt Pay Act, and disputes between the parties, including mechanics’ and materialmen’s liens. He can be reached at cdixon@swlaw.com or 602.382.6408.






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