Liquidated Damages Clauses Serves As Payment In Lieu Of Performance, Not To Secure Performance
05/23/08
Contractor entered into contract with city to construct wastewater facility. Liquidated damages were triggered after contractor failed to timely complete project. Contract included provision that “time is of the essence” and provided for liquidated damages. Liquidated damages amount was set by factoring in city’s costs to monitor the project, additional city labor incurred because of delay, additional costs of city utilities, costs of engaging other consultants, legal expenses, renting equipment to address flow situations, potential issues by regulatory agencies if the project was delayed and other unknowns. The damages were established at $850 per day.
Almost four (4) months after the agreed, modified substantial completion date, city shut down its old plant and transferred operations to the new wastewater plant, even though it was not completely operational and the computerized control system was not operational. Substantial completion was declared by the engineering consultant almost 5 months after the agreed, modified substantial completion date and final completion the next day, upon delivery of the operating manuals.
Contractor argued that liquidated damages accessed after substantial completion amounts is unconscionable, unreasonable and unenforceable and further argued that the liquidated damages amounts to a unenforceable penalty. Court finds that the propriety of liquidated damages is a question of law over which the [court of appeal’s] review is unlimited. The interpretation and legal effect of written instruments are matters of law. The primary rule for interpreting written contracts is to ascertain the parties’ intent. If the terms of the contract are clear, the intent of the parties is to be determined from the language of the contract without applying rules of construction. The interpretation of a written contract that is free from ambiguity is a judicial function and does not require oral testimony to determine the contract’s meaning. An ambiguity in a contract does not appear until two or more meanings can be construed from the contract provisions.
Here the contract documents specifically provide the engineer is to determine when the work was sufficiently complete to constitute substantial completion. The definition of substantial completion directly incorporated the definition of work. The definition of work specifically included completion of the computerized control system. Te computerized control system was not completed until five months after the contractual scheduled substantial completion date. Thus, under the plain language of the contract and the undisputed facts, contractor did not achieve substantial completion until the computerized control system was installed and met the requirements testing.
Parties to a contract may stipulate to a set amount of damages for breach of contract as long as the provision constitutes a liquidated damages clause and not a penalty. The distinction between a provision for liquidated damages and one for a penalty is that a penalty is to secure performance, while a liquidated damages provision is for the payment of a sum in lieu of performance. To determine whether a stipulated damages provision constitutes a liquidated damages clause or an unenforceable penalty, Kansas courts employ the following test: “The instrument must be considered as a whole, and the situation of the parties, the nature of the subject matter and the circumstances surrounding its execution taken into account. There are two considerations which are given special weight in support of holding that a contractual provision is for liquidated damages rather than a penalty – the first is that the amount stipulated is conscionable, that it is reasonable in view of the value of the subject matter of the contract and of the probable or presumptive loss in case of breach; and the second is that the nature of the transaction is such that the amount of actual damages resulting from default would not be easily and determinable.” TMG Life Ins. Co. v. Ashner, 21 Kan.App.2d at 250. The reasonableness of a liquidated damages clause should be determined as of the time the contract was executed, not with the benefit of hindsight.
The court went on to state that Kansas courts have not definitively answered the question whether the enforceability of liquidated damages provisions should be determined prospectively only, or whether Kansas courts would also apply a supplemental retrospective analysis. However, to recover under a liquidated damages clause, the amount of liquidated damages must bear some reasonable relationship to the actual injury caused by the breach. If such amount bears no such relationship, it is a penalty and void.
Here, it is undisputed that the city incurred actual damages (including having an engineer on site during the 5 month delay) and the amount of liquidated damages is less than 3% of the total contract price. Thus, the amount of liquidated damages was reasonable when viewed retrospectively in relation to the actual damages sustained by the city caused by contractor’s delay.
Carrothers Construction Company, LLC vs. City of South Hutchinson, Kansas, Docket No. 98,023 (Ks.Ct.App. May 23, 2008).
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