You may encounter these legal terms when handling construction contracts and surety bonds. Bid and performance bond request forms typically ask about “Liquidated Damages.” Does this refer to marine contracts?
A typical Performance Bond form may not mention liquidated damages – whether they are covered or excluded. So why does the bond request ask for this detail?
Let’s start by identifying the parties involved
- The contractor that applies for the bond is the principal. They would be the defendant in a lawsuit relating to the bond.
- The owner of the contract, the party protected by the bond, is the obligee. In that lawsuit, the obligee would be the plaintiff, bringing suit against the bond principal and surety.
- The third party to all such transactions is the bonding company or surety.
Bonded contracts can be between the project owner and a general contractor (GC), or between the GC and a subcontractor (sub). We mention this because sometimes the problems and claims “trickle down” from contract to contract and then onto the bond.
What does a Performance Bond Cover?
The bond language is specific. But remember, it is a guarantee of the contract it references. Construction contracts typically DO establish liability for contract delays, unanticipated increased expenses and other financial losses that may be attributable to the contractor’s actions or inactions. It is through the contract language that the surety becomes responsible for such losses. For this reason, damages are always an issue for bond underwriters. Let’s learn enough about them to be dangerous.
Liquidated Damages (also referred to as ascertained damages) are damages whose amount the parties designate during the formation of the contract for the injured party to collect as compensation upon a specific breach (such as late performance). Such penalties for failure to complete on time can amount to thousands of dollars per day and thus may deter a surety from supporting the contract.
It is not uncommon for general contractors (GC) to pass down the Liquidated Damage penalty in their contract, to the subs below them. The concern is that the subcontractor’s lack of performance could jeopardize the timely completion of the entire project.
When parties contract for liquidated damages to be paid, the clause will be enforceable if it involves a genuine attempt to quantify a loss in advance and is a good faith estimate of economic loss.
Actual Damages In a breach of contract case the prevailing plaintiff may be entitled to actual, or compensatory, damages.
Actual damages can be split into direct and consequential damages.
- Direct damages result naturally from the defendant’s wrongful conduct. The defendant will have foreseen the damages would result from the breach. The benefit of the bargain that is directly and strictly tied to the contract is a measure of direct damages.
- Consequential damages result naturally but not necessarily from the defendant’s wrongful conduct. Consequential damages must be foreseeable and directly traceable to the breach of contract. Lost profits, lost sales, incidental damages and most other damages are consequential damages.
- Consequential damages (also sometimes referred to as indirect or special damages) may be recovered if it is determined such damages were reasonably foreseeable or “within the contemplation of the parties” at the time of contract formation. This is a factual determination that could lead to the contractor’s liability for an enormous loss. For example, the cost to complete unfinished work on time may pale in comparison to the loss of operating revenue an owner might claim as a result of late completion.
It is important to note that the definition of what the bond covers is only limited by the imagination of the presiding court. Certainly it is true that the interpretation of bond coverage has expanded the exposure of sureties. Here are some examples of losses courts have determined are covered by performance bonds:
- Municipal Bond Interest
- Loss of Use of Building Site
- Interest on Construction Loan
- Loss of Rents
- Liquidated Damage
- Lost Profits
- Loan Interest
- Delay Damages
- Lost Rental Income
- Unemployment Insurance Taxes
- Prevailing Wage and Overtime Violation Penalties
- State and Federal Taxes
- Lost Equity Delay Damages
- Loan Repayment
In conclusion, we must keep in mind that the surety’s obligation is defined by the bond and the contract.
Does the surety have the opportunity to review the upcoming contract when considering the bid bond? It would be unusual if they did! This is why the underwriting questions are so important.
We all know contracts can vary, but bonds can vary too. It is imprudent to make assumptions in this area. Read the bond and read the contract. If necessary, ask for a written legal interpretation.