Liquidated Damages in Real Estate Construction Contracts Misconceptions

Many times we at Gem Engserv Pvt. Ltd. get assignments that require us to review the construction contract documents for the Developers. More often than not we come across incorrectly drafted contract clauses that are really hard to correct unless redrafted.

Gem Eng Services - Mr. Jagdish Raje

                                                 Mr. Jagdish Raje

I am going to discuss the commonly occurring mistakes that we have come across.
First mistake is that liquidated damages are confused with withholding money. The developer intends to withhold certain part of the Contractor’s dues for a default during the tenancy of the contract and on the rectification or mitigation of that default by the Contractor, the clause provides for release of the withheld money. Such a withholding is erroneously called as liquidated damages.

This is wrong on two counts. Any “damage” is an equitable compensation for a breach of contract and such compensation should be consistent with the loss suffered due to the breach. Therefore returning money to the contractor after mitigation or rectification of the breach violates the above principle of claiming damage. Secondly the term “liquidated damage” means the genuine pre-estimate of the loss to a party (most    commonly the developer) due to non- performance of the other party (most commonly the Contractor). Such liquidated damages are required to be quantified at the commencement of the contract and taken as equivalent to maximum loss that a party (the developer) is going to suffer due to the non-performance of the other party (the contractor). Liquidated damages can be claimed only at the non-occurrence of any named event such as achievement of a milestone or the timely completionof the construction work.

While it is possible for a developer to be entitled to claim damages for the nonachievement of the named milestones as part of the overall liquidated damages, such part liquidated damages should be named as such in the contract and
cannot be returned on achievement of the milestone at a later date. In such cases the amount that can be claimed as the remaining liquidated damages for non-achievement of the overall completion of the construction work should be
expressly stated to be in addition of the abovementioned part liquidated damages.

Though the liquidated damages are an agreed compensation for nonachievement of a stated event, claiming the maximum amount can be challenged and the onus of proof for having incurred the damage lies with the
party claiming the damage. A developer can easily surmount this obstacle. The second most commonly occurring mistake is that the date from which the liquidated damages are applicable is not clearly defined. Ideally it should be from the non-occurrence of a stated event such as the scheduled completion date of the construction work. Poorly drafted contracts fail to define as to what signifies the completion of construction work. Also the treatment of delays and the compensable events are not stated clearly. There are many other mistakes that are less common but occur all the same.

When such mistakes are pointed out, the wailing that is often heard is “We have been using this clause for a number of years now and it has worked fine” Well, may be. But RERA has made it difficult for the developers to not deliver projects on time and much of their ability to do so rests with their contractor. Also, there are only a few construction contractors in India who can deliver complicated tall buildings on time with a certainty. Needless to say these contractors have the ability to take advantage of any loosely drafted clause.

So here is hygiene list for claiming liquidated damages

1. Define the specific event against which the liquidated damages can be claimed. If the liquidated damages are to be claimed against nonachievement of an interim milestone and/or the overall completion, the criterion for deciding the non-achievement should be stated.
2. Compensable and excusable treatment of delays shall be clearly stated.

3. At the earliest possible opportunity after non achievement of the stated event, the aggrieved party must state the intention to claim the liquidated damages.

4. The liquidated damages once claimed cannot be returned under the provisions of a contract.

                                                                                                                                             -By Jagdish Raje