Hindsight is not 20/20 when Interpreting Liquidated Damages Clauses in Public Contracts
February 29, 2016
Liquidated Damages Provisions Generally
Typically, courts in Ohio (and elsewhere) follow a well-known principle of interpreting contract language so as to carry out the intent of the parties, when that intent is evidenced by clear, contract language. This is especially true in commercial settings where courts deem each party on equal footing, able to secure counsel and able to understand sophisticated business principles. In other words, courts will generally uphold language in commercial contracts, unless contrary to statutory law or public policy. Consequently, commercial parties have a lot of leeway in allocating the risk of a particular deal. One way parties to a contract allocate risk is to insert a “liquidated damages” provision into a contract.
“Simply stated, liquidated damages are damages that the parties to a contract agree upon, or stipulate to, as the actual damages that will result from a future breach of the contract. The effect of a clause for stipulated damages in a contract is to substitute the amount agreed upon as liquidated damages for the actual damages resulting from breach of the contract, and thereby prevent a controversy between the parties as to the amount of damages.” The law in Ohio and elsewhere regarding liquidated damages provisions in real estate and construction contracts is that when they are fair and reasonable attempts to fix just compensation for anticipated loss caused by breach of contract, they are enforced; alternatively, when they are penalties, or punishments for default, they are not enforced. The difficult problem, in each case, is to determine whether or not the stipulated sum is an unenforceable penalty or an enforceable provision for liquidated damages.
Enforceable Liquidated Damages Provision or Unenforceable Penalty-The 3 Part Test
To help provide guidance, the Supreme Court of Ohio in Samson Sales, 12 Ohio St.3d at 28, 465 N.E.2d 392 set forth a three-part test to determine whether a contractual provision should be considered an enforceable liquidated-damages provision or an unenforceable penalty. The court held: “Where the parties have agreed on the amount of damages, ascertained by estimation and adjustment, and have expressed this agreement in clear and unambiguous terms, the amount so fixed should be treated as liquidated damages and not as a penalty, if the damages would be (1) uncertain as to amount and difficult of proof, and if (2) the contract as a whole is not so manifestly unconscionable, unreasonable, and disproportionate in amount as to justify the conclusion that it does not express the true intention of the parties, and if (3) the contract is consistent with the conclusion that it was the intention of the parties that damages in the amount stated should follow the breach thereof. For example, a clearly written provision in a $300,000 construction contract between private parties calling for liquidated damages of $150,000 for not completing the building on time would probably be held as a penalty because the penalty is unfairly disproportionate to the amount of the contract.
What about Liquidated Damages Provisions in Public-Works-Construction Contracts? (Boone Coleman Constr., Inc. v. Piketon, Slip Opinion No. 2016-Ohio-628)
Should public contracts be interpreted any different? Should the “Samson Test” be applied in public as well as private contracts? What if a seemingly fair liquidated damages provision of $700/day for each day late (measured at the beginning of a contract) seems not so fair when measured at the end of the contract because of a 365 day delay? Would that be a penalty or a fair measure of liquidated damages? These were the issues recently faced by the Ohio Supreme Court in “Boone”.
The facts of the case seem simple and straight forward. In 2007, appellant, the Village of Piketon, solicited bids for the “Pike Hill Roadway and Related Improvements” project (for the installation of a traffic light and roadway improvements at the intersection of U.S. Route 23 and Market Street in Piketon). Appellee, Boone Coleman Construction, Inc. submitted the lowest bid and was hired for the project. The parties entered into a contract in which Piketon agreed to pay Boone Coleman $683,300 to complete the work. The contract expressly provided that the time was “of the essence” with regard to completion of the project. A liquidated-damages clause provided that Boone Coleman would pay $700 to Piketon for each day after the specified completion date (120 days after contract signing) that the contract was not substantially completed. The contract provided, in pertinent part: “OWNER and CONTRACTOR agree that as liquidated damages for delay (but not as a penalty), CONTRACTOR shall pay OWNER $700.00 for each day that expires after the time specified in paragraph 4.02 for Substantial Completion until the Work is substantially complete”.
Boone Coleman did not complete the project until July 2, 2009― over a year after the parties’ extended the completion date. Boone Coleman brought suit against Piketon in the Pike County Common Pleas Court, alleging, among other things that Piketon had improperly failed to pay $147,477 of the contract price for the construction. Piketon counterclaimed for liquidated damages. The trial court granted Piketon’s motion for summary judgment, awarding Piketon $277,900 in liquidated damages. Boone Coleman appealed, asserting that the trial court erred in awarding Piketon liquidated damages. The appellate court agreed. They applied the Samson Test but found the $277,900 in liquidated damages was clearly disproportionate to the $683,000 contract price. Piketon then appealed to the Ohio Supreme Court who overruled the appellate court and upheld the applicable provision for liquidated damages of $700 per day for delay of completion.
The Ohio Supreme Court also applied the Samson Test in Boone and agreed that the appellate court properly applied the first and third parts of the test. The appellate court properly recognized that “the damages incurred as a result of a delay [by Boone Coleman in completing the project] were uncertain as to amount and difficult to prove” and that “the plain and unambiguous language of the liquidated damages clause is consistent with the conclusion that the parties intended that damages in the amount of $700 per day would follow the contractor’s breach of the project completion deadline.”
The Supreme Court of Ohio, however, disagreed that the 2nd prong of the Samson Test (regarding disparity between the liquidated damages and contract amount) was properly applied by the appellate court. According to the Ohio Supreme Court, “The correct analysis looks at whether it was conscionable to assess $700 per day in liquidated damages for each day that the contract was not completed, rather than looking at the aggregate amount of the damages awarded [after the fact].” In other words, the Ohio Supreme Court directs us to look at the per diem damage amount, prospectively, rather than the total sum, after the fact (which the appellate court focused on).
Also important to the court in Boone overturning the appellate court’s decision is the nature of public vs. private construction contracts. Every Ohio-funded public-improvement construction contract, for example is required by the Ohio Revised Code to include a liquidated-damages provision. (See O.R.C. Section 153.19). In other words, liquidated damages provisions in public contracts are seemingly more appropriate because they are sanctioned by the Ohio General Assembly. Moreover, the Ohio Supreme Court recognized that contractors in public works contracts need to answer to a “higher authority”; the public. As stated by the Supreme Court in Boone, “We recognize that liquidated-damages provisions in public construction projects play an important civic purpose in that they help foster timely completion of the project, thereby avoiding the loss of billions of taxpayers’ dollars caused by contractors’ delays.” In other words, (according to the court), “the protection of the public interest is a proper consideration in determining [the] validity of a liquidated damages provision.”
Finally, important to the court’s holding was the fact that the liquidated damages clause in Boone was a per diem amount vs. a lump sum, and “in failing to recognize this distinction, the appellate court committed its second error.” Citing precedent, the Ohio Supreme Court in Boone stated, “[T]he agreement to pay a specified sum weekly during the failure of the party to perform the work, partakes much more of the character of liquidated damages than the reservation of a sum in gross.”
What is the moral of this story? To quote Benjamin Franklin (as cited by the court), “Time is Money.” In other words, caveat public contractor. Watch your language with liquidated damages clauses in public works contracts. Reasonable, per diem liquidated damages set at the outset are likely to be enforceable, even if they total, at the end, a disproportionate amount to the original contract price.