It is not uncommon for parties to agree to a liquidated-damages clause in a construction contract. The general theme of such a provision is that if the contractor does not complete construction within a certain number of days after construction begins, the contractor will be liable to the owner for a certain amount of money for each day beyond the contractual completion date. While there may be other unreasonable things consenting adults may legally do in private, one thing they cannot do is agree to unreasonable liquidated damages.
The general rule in Wisconsin is that a liquidated-damages clause is enforceable only if the clause is reasonable under the totality of the circumstances. This reasonableness test is supposed to prevent abuse by one party in exercising its bargaining leverage. Wisconsin courts consider several factors in determining whether a liquidated-damages clause is reasonable, including:
- Whether the parties intended to estimate damages or intended to punish one party.
- Whether, at the time the contract is signed, it is difficult or impossible to accurately estimate the injuries caused by a delay in completion.
- Whether the stipulated damages are a reasonable forecast of future harm caused by a delay in completion.
In a May Wisconsin Court of Appeals decision, Cammarata v. Pheasant Run Partnership, the court ruled that the liquidated-damages clause in a construction contract was unreasonable and unenforceable. In that case, an owner entered into a contract with the builder for the construction of a condominium. An addendum to the contract contained a liquidated-damages clause that provided a $200 per day penalty against the builder for a delay in the condominium’s completion. The condominium was not completed on time, and the owners sued the builder seeking to enforce the stipulated damages clause. The owners did not allege or seek to recover actual damages. Considering the factors set forth above, the court concluded that the liquidated damages were not a reasonable forecast of anticipated damages. The parties’ deposition testimony established that the owners did not know where the $200 was derived and, consequently, the figure did not represent an attempt by the parties to reasonably forecast future damages. While the owners’ affidavits stated that they had suffered actual damages because their home decreased in value, there was nothing in those affidavits that indicated that the liquidated-damages amount was based on that anticipated loss. Because the owners only sought the amount of the liquidated damages and did not allege actual damage, the court of appeals opined that the trial court properly granted the builder’s motion for summary judgment and dismissed the case.
Here are some lessons that may be drawn from this case:
- If you agree to a liquidated damages provision, it could come under scrutiny later. You should not assume that it will be disregarded – or honored — by the court.
- When drafting or negotiating a contact containing a liquidated-damages provision, you should consider the "reasonableness" factors described above.
- When a liquidated damage provision is used, other related provisions should also be adequately addressed. For example, if the contract provides that the contractor must achieve substantial completion within a certain amount of days after construction begins, then the factors establishing the start date (e.g., within a certain amount of days after the issuance of a building permit) and the "substantial completion" date (e.g., upon the issuance of an occupancy permit) should be clearly defined. The events establishing contract-time extensions (e.g., acts of God, strikes, adverse weather condition and other conditions beyond the reasonable control of the contractor) should be clearly defined as well.