What are liquidated damages, and how can I avoid paying them?

Scheduling a project is an exciting process. Laying out all of the deliverables, establishing milestones, and envisioning the final project coming together is rewarding. What happens when cracks start to show in the smooth facade the scheduler has established?

Scheduling a project is an exciting process. Laying out all of the deliverables, establishing milestones, and envisioning the final project coming together is rewarding. What happens when cracks start to show in the smooth facade the scheduler has established?

Weather events, unexpected delays in materials, or unexpected factors on the site can delay the project here and there, until it’s clear a project is not going to be delivered on time. KPMG’s 2015 Global Construction Survey found that only a quarter of projects come within 10% of their original deadlines. Such a situation is stressful for many reasons, including the fact that a delayed project costs more money in equipment rentals and labor costs. If the entire project runs late, a contractor can be on the hook for some very expensive liquidated damages.

Liquidated damages 101

Liquidated damages are funds allocated to the owner in the case that a project is not completed on deadline. They are often deducted from the amount an owner owes to a contractor for the completed work. Agreed upon in advance as part of the engagement contract, liquidated damages are meant to cover costs incurred or income lost because of the time overrun. A good example of this is a private school that’s not completed for the beginning of a school year, so the owner loses out on tuition.

How much money will I owe if a project runs late?

Liquidated damages are often considered to be an extra incentive for the contractor to meet an agreed deadline, but they can’t be egregious price-gouging either. If the amount set is so high that it’s considered punitive for the contractor, the owner may be required to prove in court how much money the delay actually caused. Because it’s nearly always preferable to stay out of court, a reasonable estimate of damages should be listed in the contract so both parties can agree on the dollar value.

Some contracts are specific enough to allow for damages for missed milestones in the project. In that case a contractor could be on the hook for multiple damages concurrently when things run late.

Since there are so many mitigating factors that could cause a project to run long, the contract should include provisions for extending the timeline without incurring damages. Owner changes to the nature of the work, for example, shouldn’t be considered the contractor’s fault.

Still, damages are a daily fee, and a time overrun can lead to serious profit margin erosion, eating into a contractor’s financial gain on a project.

Avoiding the cost of liquidated damages

Construction projects are extremely complex, so refiguring a schedule once it’s begun may be very challenging. Time pressure can make it hard to follow good processes at the best of times. When a project falls behind, taking the time to follow protocols to reestablish an efficient plan of action can be even tougher.  As a recent McKinsey article puts it, “Bad processes lead to bad outcomes in a vicious cycle.”

Luckily, there are solutions that can help calculate next steps to right a project and keep it moving. ALICE is a parametric solution: it changes the entire project timeline in response to altered inputs, mapping out the way for project completion. That’s how ALICE has saved its customers tens of millions of dollars in liquidated damages - by calculating the optimal mix of crews to achieve project goals.

Here’s a prime example: on a recent road project, inputs from the bid schedule were fed into ALICE, which showed the project was exposed to a 120 day delay. That would have cost $12M in liquidated damages! ALICE was able to show them the optimal mix of crews to achieve the project's goals.

The best-case scenario for both contractors and owners is for the project to stay as close to the original schedule as possible. The original schedule should be realistic, allowing for those inevitable setbacks. Finally, the project team should be ready to set things back on track when things go awry. ALICE can help show the way, from bidding and preconstruction, through to the successful finish of a project.

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