Liquidated Damages: what, when, & why

Posted on September 30, 2010 by Melissa Dewey Brumback

What are Liquidated Damages?

Liquidated Damages are a sum which a party to a contract agrees to pay or a deposit he agrees to forfeit, if he breaks some promise. In the construction realm, liquidated damages (or “LDs”) usually involve money damages for time delays on a construction project. Typically, a contract will state that time is “of the essence” and that for every day past the scheduled completion date (as modified by change orders & directives) a set amount is due from the contractor to the owner.

When can you get liquidated damages? (or, when must you pay liquidated damages?)

Liquidated damages must be specified in the contract up front. They should reflect the reasonable estimate of likely damages that will be incurred if the contractor fails to complete the project timely.

To be enforceable, the amount must have been arrived at by a good-faith effort to estimate in advance the actual damage that would likely ensue from the breach, and they cannot be deemed “penalties.” Eastern Carolina Internal Medicine, P.A. v. Faidas, 149 N.C.App. 940, 564 S.E.2d 53 (2002).

Why?

The purpose of liquidated damages is to reasonably compensate the non-breaching party (typically, the owner for construction delays) which it will likely incur as a result of the breach (e.g., the extended completion date results in lost rent and increase finance charges). Without the liquidated damages provision, the parties would be forced to argue about each alleged cost the owner incurred because of the delay. With liquidated damages, the amount is known ahead of time which should (theoretically) lead to fewer arguments later.

When doesn’t the provision work?

Two words—concurrent delay. If the owner is delaying the project (through, for example, failure to deliver/install owner-provided equipment), but the contractor is also behind on completion, the two delays may run at the same time—hence “concurrent delay”. In such a situation it becomes difficult if not altogether impossible to separate delays and delay damages. Of course, if the entire delay is owner-related, no liquidated damages can be assessed.

Take-away message

Liquidated damage provisions, if carefully and properly drafted, are enforced in North Carolina. You should know your schedule requirements prior to signing on the dotted line and, if necessary, accelerate your work to complete on time. If you are the owner, however, you also have responsibilities not to interfere with the schedule if you hope to have a chance at recovering liquidated damages from a contractor who delivers a project late.

Questions? Comments? Experience with the joys (and sorrows) of LDs? Share in the comments below.

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Photo “Water drop bouncing off the water surface” by konradc via Picasa/Creative Commons License.

What is Indemnity, and why should you care?

Posted on September 16, 2010 by Melissa Dewey Brumback

If you have ever asked a lawyer to review your construction contracts (and you should have), you may have noticed that lawyers get very excited over the indemnity provisions that may or may not be in the contracts you are contemplating signing. What are indemnity provisions, and why should you care?

What is it?

Quite simply, an indemnity provision is a statement that one of the parties agrees to pay any sums the other party might otherwise be legally required to pay to a third party. Now that I’ve mentioned picking up someone else’s tab, I hope I have your attention. As you might imagine, an indemnity provision can be a costly item, so you should have a thorough understanding of what such a provision means.

In general, indemnity provisions are contractual, and contract rules concerning them apply. What that means is, if the contract says you will pay for the owner/builder/developer/designer’s legal liabilities to others, you may have to open the checkbook.

Common Indemnity Provision

An example of one type of indemnity provision is AIA A201 3.18.1, which states:

To the fullest extent permitted by law the Contractor shall indemnify and hold harmless the Owner, Architect, Architect’s consultants, and agents and employees of any of them from and against claims, damages, losses and expenses, including but not limited to attorneys’ fees, arising out of or resulting from performance of the Work, provided that such claim, damage, loss or expense is attributable to bodily injury, sickness, disease or death, or to injury to or destruction of tangible property (other than the Work itself), but only to the extent caused by the negligent acts or omissions of the Contractor, a Subcontractor, anyone directly or indirectly employed by them or anyone for whose acts they may be liable, regardless of whether or not such claim, damage, loss or expense is caused in part by a party indemnified hereunder. . . .

When is it not legal?

There are some exceptions to the general applicability of indemnity provisions in North Carolina—most noticeably: you cannot be indemnified against your own negligence. If an indemnity provision purports to indemnify one party against that person’s own negligence, public policy and state law prohibit such an indemnification in North Carolina The applicable statute N.C. Gen. Stat. §22B-1, which reads:

§ 22B-1. Construction indemnity agreements invalid

Any promise or agreement in, or in connection with, a contract or agreement relative to the design, planning, construction, alteration, repair or maintenance of a building, structure, highway, road, appurtenance or appliance, including moving, demolition and excavating connected therewith, purporting to indemnify or hold harmless the promisee, the promisee’s independent contractors, agents, employees, or indemnitees against liability for damages arising out of bodily injury to persons or damage to property proximately caused by or resulting from the negligence, in whole or in part, of the promisee, its independent contractors, agents, employees, or indemnitees, is against public policy and is void and unenforceable. Nothing contained in this section shall prevent or prohibit a contract, promise or agreement whereby a promisor shall indemnify or hold harmless any promisee or the promisee’s independent contractors, agents, employees or indemnitees against liability for damages resulting from the sole negligence of the promisor, its agents or employees.
[Emphasis added].

However, construction indemnity clauses indemnifying a party for its own negligence can be valid and enforceable so long as the offending portion of the indemnity clause can be redacted (that is, stricken from the paragraph). Vecellio & Grogan, Inc. v. Piedmont Drilling & Blasting, Inc., 183 N.C.App. 66, 644 S.E.2d 16 (2007). In the example of the AIA A207 provision above, the phrase “To the fullest extent permitted by law” acts to keep the phrase within the permissible parameters of North Carolina law. Therefore, if you signed a contract with such a provision, you may be on the hook.

Be Careful with Indemnity Provisions

Not all indemnity provisions are equal. Some, such as in the above example, make attorney fees part of the expense which is passed along. Others expressly exclude attorney fees. Some provisions include a “duty to defend” on behalf of the other party, while others are silent on that issue. What is most important is that you recognize that such language is extremely important and should be discussed in detail with your knowledgeable construction lawyer.

As with getting your hair cut, you could do it yourself, but should you?

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Photo “Barber Shop Pole” by MyEyeSees via Flickr/Creative Commons License.

NC surety bonds- what they are; how they work (Guest Post)

Posted on September 2, 2010 by Melissa Dewey Brumback

Today, another guest post– this time from Danielle Rodabaugh, a principal for Surety Bonds.com, an agency that issues surety bonds to individuals and businesses throughout the nation. She aims to clarify bonding rules & regulations, and has recently been focusing on construction/contract bonds. Danielle will be discussing bonding issues within the North Carolina construction industry.

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Reliable professionals working in the construction industry want to guarantee the quality of their work to their clients, and that’s where surety bonds come in. In construction, contract (or construction) bonds are a type of surety bond utilized to ensure that professionals follow regulations and make appropriate decisions while working on a project. Construction bonds typically protect the client and work similarly to insurance—although they offer a different kind of protection.

What’s a surety bond?
In the construction industry a surety bond is essentially a legal agreement between three parties to help ensure the fulfillment of a contract:

Obligee–typically the developer or worker who receives the protection of the bond, guaranteeing that the contractor fully completes the project
Principal–the contractor who gets the bond, guaranteeing that they will fulfill various aspects of the project as outlined in the contract
Surety–the agency who issues the bond to the principal, thus backing the contractor’s work and acting as an intermediary between the contractor and obligee

There are three main types of construction bonds that are utilized in North Carolina:

bid bonds
performance bonds
payment bonds

Each of these bonds plays a different role in guaranteeing the work of a contractor throughout a project’s duration. North Carolina surety bond agencies have the ability to issue construction bonds to qualifying professionals who want to take advantage of their benefits. Unfortunately, many working in the construction industry are still unaware of the legal financial protection offered by construction bonds.

Bid Bond Issues in North Carolina
Bid bonds guarantee a developer that—if selected—a contractor will agree to work on a project for the amount proposed in the original bid. This guards against contractors who might try to increase their bid on a project after being contracted by the developer. With a bid bond in place, the developer may collect appropriate reparation if the contractor breaks the bond’s terms. If such a situation arises, the resulting compensation is typically calculated by how much more the developer has to pay to contract the next-lowest bidder for the project. If the contractor does not have the ability to adequately compensate the developer the surety becomes responsible for paying reparation up to the bond’s full value.

Although North Carolina state law does not require the use of bid bonds on either private or public construction projects, a developer may still choose to require them as an added form of protection. According to N.C. Gen. Stat. s. 143-129, which outlines the procedure for letting of public contracts, North Carolina contractors must provide an upfront deposit in the amount of 5% of the total bid when submitting their bid. The language explains that a contractor may choose to provide a bid bond in lieu of making the required cash deposit. Bid bonds can be especially helpful for new contractors who may not have the necessary cash on hand for the collateral, as the surety would financially back the contractor’s bid.

Performance Bond Issues in North Carolina
Contractors secure performance bonds to guarantee that they will perform all aspects of a project as outlined in the contract. Should the contractor fail to complete the project satisfactorily, the performance bond allows the developer to regain appropriate compensation. If the contractor cannot pay the reparation then the performance bond instructs the surety to step in. Depending on the situation, the surety might be responsible for paying retribution up to the bond’s full face value for any extra fees incurred as a result of the contractor’s incomplete work.

Performance bonds are not required for private projects in North Carolina, however some regulations mandate their use for certain public ones. For example, the use of performance bonds is required when any government entity enters into a construction contract in an amount more than $100,000. Furthermore, they are also required for any other public construction project that exceeds $15,000, no matter the developer or specific contract. Additionally, any developer has the right to require a selected contractor to get a performance bond prior to a project, which especially benefits the developers of private projects or smaller projects that cost less than $15,000. All state-mandated performance bonds must be issued for 100% of the project’s contracted cost.

Payment Bond Issues in North Carolina
Payment bonds are put in place to make sure that contractors will pay all labor and material costs as outlined in the contract. Because mechanic’s liens—which ensure payment of outstanding debts upon sale of a property—can only be used on private property projects, payment bonds are essential to making sure that all bills are paid in full. Subcontractors (or other workers) can make a claim on the bond if a contractor does not make the appropriate payments, allowing them to recover deserved compensation.

Simply put, payment bonds are required on all projects that mandate the use of performance bonds. North Carolina General Statute 44A-27 explains that any professional working on a bonded project who is not paid for his labor within 90 days has the ability to make a claim on the bond. Private projects in North Carolina do not require the use of payment bonds, although these individuals may elect to use them at their own discretion. This goes to show that although bonds are not always be required in North Carolina, they are most certainly enforced. Oftentimes this means that individuals working within North Carolina’s construction industry must take the initiative to utilize construction bonds.

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Danielle and I welcome your thoughts, comments, and questions about surety bonds in the comments section, below.

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Photo “Checking the bond” by Stephen via Picasa/Creative Commons License.

Joint & Several Liability in NC (law note)

Posted on August 26, 2010 by Melissa Dewey Brumback

If a client has been sued, he wants to know how much is at risk if he loses at trial. This is especially true where more than one person or company have been sued. How is any damage award apportioned?

The answer is not one clients generally like to hear: your company can be on the hook for 100% of any damages. This is true even if your company is really only liable for a tiny fraction of what caused the damages in the first place. You can thank “joint and several liability” for that.

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For example, in a fairly typical construction dispute, an owner sues a contractor and the architect for construction defects. The contractor uses unsuitable substitutions, and the architect approves the unsuitable substitutes. Both contractor and architect may be held liable for the resulting damages. If a jury awards the owner $500,000, then both contractor and architect are liable for the entire $500,000 to owner. That’s the “severability” part of the law. As between the two, of course, they both share in the damages, and if the owner executes on the entire judgment against the architect (perhaps due to the architect’s insurance coverage), the architect can then go after the contractor for an equal share and get paid back $250,000 in “contribution.” (That’s the “joint” nature of such an award). This is, however, assuming the contractor has those funds. Essentially, whoever has the funds when a judgment hits might end up paying for the entire award. If the contractor doesn’t have $250,000 for the architect to be paid back, the architect is out of luck.

Does the result change if the jury finds the architect was only 5% liable for the damages and 95% were attributed to the contractor? Nope. In North Carolina, where the parties’ actions together contribute to one indivisible injury, there is no apportionment. “In for a penny, in for a pound” as the old saying goes.

Exceptions to the Rule?

Are there exceptions? But of course! If the owner is also negligent, he can get no recovery at all since North Carolina is a pure contributory negligence state. If one party is actively negligent and one passive, than the passively negligent party can seek indemnity from the active party. If one party settles before trial, things become more complicated. More on these subjects in future posts. I’m also told that in other states apportionment is more the rule, so you may have better luck with your out of state projects in a similar situation.

As a general rule of thumb, however, for your North Carolina project, just assume that the entire amount of claimed damages may be presented to you for payment. Unfair? Many times, yes. That’s the nature of the beast. It is also one of many, many good reasons to make sure you are doing business with people you trust and, more importantly, that other professionals are appropriately insured or bonded on any project you are working on.

If you have any questions about joint and several liability, drop me a line or a comment below.

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Photo “Shiny pennies” by David Pillbro (Flickr Creative Commons license)

Tolling the Statutes of Limitation & Repose? (Law note)

Posted on August 19, 2010 by Melissa Dewey Brumback

A blog reader recently raised the question of to how to handle construction defect claims while repair attempts are being made on a defective building. In part, the answer to this question will depend on how close you are to the statute of limitations or the statue of repose from running. The closer you are, the more you need to be concerned about this issue. Just because all parties are working together to solve construction issues does not mean that the statutes are not running. They can. [There are, as usual, exceptions for equitable reasons.] And once statues run, there’s no getting them back.

One prudent approach to dealing with the statutes is to have all parties involved enter into a “Tolling Agreement.” What a properly drafted tolling agreement can do is to stop the running of the statue of limitations and/or repose while the parties attempt to fix the defects or otherwise settle their issues with one another. Note that the tolling agreement does not give a party any greater rights than they would have at the time it is signed– that is, if the statute has *already* run, then it would be of no use. But the tolling agreement can act as a “time out” on the running of the clock.

A good example of a tolling agreements is found in the Court of Appeals opinion in Charlotte Motor Speedway, Inc. v. Tindall Corporation, 195 N.C. App. 296, 672 S.E.2d 691 (2009). The Speedway case involved the infamous collapse of a pedestrian walkway during the NASCAR Winston Cup. The walkway which collapsed had been substantially completed by October 1995, and the collapse occurred in May 2000. Speedway (the project owner) and Tindall (which constructed the walkway) entered into a tolling agreement:

“to toll and suspend any applicable statute of limitations, repose or time, whether created by statute, contract, laches or otherwise, within which any cause, claim action, cause of action, or suit must be made, or commenced by the parties against any one of them concerning the [pedestrian] claims, including any and all claims for indemnification and contribution.” Id. at 298, 672 S.E.2d at 693.

Tindall attempted to argue that the statute of limitations barred Speedway’s claim for indemnification of monies paid prior to three years before it filed its complaint, but the Court found that the Tolling Agreement, which remained effective “through and including January 1, 2006” tolled the action, and Speedway brought suit on July 17, 2007, less than two years after the Tolling Agreement expired. Likewise, the Court held that the statute of repose did not bar the action, because the Tolling Agreement was entered into less than six years after substantial completion, and the lawsuit was brought during the pendency of a second funding [tolling] agreement between the parties.

If you are considering a tolling agreement (or think you don’t need one because you “have time”), it is always smart to get a professional opinion on the matter.

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Comments? Let me know. I welcome the opportunity to discuss how the statute of limitations and repose may be tolled in your specific situation.