A. The answer to your question regarding liquidated damages would depend on your state law, and thus you should submit this question to your counsel's office for a determination based on state law. Generally, a liquidated damages clause in the contract allows for the payment of a fixed sum for which a party to the contract is liable upon the breach of that contract. State law governs the formation, breach and termination of the contract. (Revised: August 21, 2009)
Q. Is it possible to assign negative incentives in a federally funded contract that are not liquidated damages (e.g. disincentives)? I am aware that the dollar amount of the "disincentive" cannot be so high that it is considered a penalty but is there such a thing as a non-liquidated damage disincentive? I'm planning some future service contract procurements and I would like to add disincentives for poor performance.
A. Penalties are not allowable per public policy. However, you may include liquidated damages in supply and services contracts, as does New York City Transit. NYCT treats poor performance by its transit service provider as potentially "damaging" to NYCT and they have attempted to quantify the damages in their clause.
You should consult with your legal counsel, but we would say that you would have to be able to rationalize the amount of "damages" in order to enforce a monetary deduction in the contract payments for poor performance. There are of course other ways to incentivize contractor performance; e.g., use of a Cost-Plus-Award-Fee contract. In this scenario, a pool of award fee dollars is established in the contract and the contractor's performance is evaluated periodically so that the agency can then determine how much fee should be awarded for a given performance period. If the performance is poor, then the agency may decide to award little or no fee for the period. Any fee "lost" in one period is not carried over to future periods. (Revised: August 1, 2009)
Q. Our agency is out for bid for a truck that will be funded in large part by our State. However, it has to be delivered by the end of the year. We would like to put a large per day liquidated damage provision in the contract. I know we have to justify any liquidated damages and the justification is the loss of funding. Do you have any comments on liquidated damages and is there a limit to how much we can put in the bid?
A. You should document the file to show that the amount of liquidated damages represents a reasonable forecast of what your actual damages will be. If you have a dispute and the case is litigated, the courts have not been willing to enforce what they consider to be a penalty, or an amount that is punitive in nature.
If the liquidated damages are set very high the contractor may pass along to you the risk the contractor is taking in the form a higher price.
If the issue is loss of state funding for the truck, would not the state funds be "obligated" at the time of contract award rather than at the time of payment of the contractor? This is how the Federal system works, so that once the contract is awarded and the government is obligated under the contract, the funds are considered "spent." (Reviewed: August 21, 2009)
Q. In a contract is there provision to deduct both Liquidated Damages and Penalty for failure in adhering to the delivery dates?
A. The subject of Liquidated Damages is discussed in the Best Practices Procurement Manual (BPPM) section 8.2.3 Liquidated Damages. The BPPM is available online here. As noted in the BPPM, the courts will not enforce the liquidated damages provision if they construe them to be a penalty. Liquidated damages are intended to compensate the owner for real economic damages and not to be used as a penalty. It is likely that a court would consider the imposition of both liquidated damages and a penalty for late delivery to be punitive and thus unenforceable. (Revised: August 21, 2009)
Q. What is the difference between Liquidated Damages and Performance Bonds?
A. Liquidated Damages (LDs) are a specific sum of money stipulated by the contracting parties as the amount to be recovered for each day of delay in delivery or completion of the project. They do represent the owner's actual damages but are established in the contract as a substitute for actual damages. They should represent the most realistic forecast possible of what the actual damages are likely to be. They are widely used in construction contracts and sometimes in supply and service contracts. For more information, see the Best Practices Procurement Manual (BPPM) Section 8.2.3 – Liquidated Damages. LDs are normally capped in the contract; i.e., there is a maximum amount stipulated in the contract that may be assessed against the contractor for late delivery. In the event of contractor default the owner will complete the project with another contractor and assess the added cost beyond the original contract amount to the defaulting contractor.
A Performance Bond is a binding promise from a bonding company ("the surety") that promises to perform those obligations of the contractor ("the principal"), when the contractor fails to perform its obligations, in an amount up to but not exceeding the amount of the bond ("the penal sum"). A performance bond protects the owner from financial loss should the contractor fail to perform the contract. The bonding company promises, for a price paid by the contractor and passed through to the public again in the amount of the bid, to perform the contract at the price agreed to in the contract if the contractor itself fails to do so. If the contract contained liquidated damages, the surety would also be responsible for paying those damages to the owner in the event the project is not completed on time. For more information, see the BPPM Section 8.2.1 – Performance Bonds. (Revised: August 21, 2009)
Q. During the contract signing our client wants to impose penalties to a maximum of 10% of the contract value. We are proposing to accept the delay against liquidated damages and not against penalties. Please clarify if we are right. Also, please let us know the difference between penalties and liquidated damages. We are about to sign a big contract with a multi-national company.
A. The topic of liquidated damages (LDs) is discussed in the Best Practices Procurement Manual (BPPM) section 8.2.3 – Liquidated Damages.
As you review this topic you will see that LDs are designed to reflect what the owner reasonably estimates the economic damages will be in the event of late delivery or completion. LDs are not intended to be a penalty, and if the courts construe the LDs to be a penalty and not a reasonable estimate of actual damages, they will not enforce the LD provision.
Contracts with liquidated damages clauses should also contain "excusable delay" clauses. These typically provide that if the contractor is delayed by certain specified causes that are beyond the contractor's control (e.g., weather, strikes, natural disasters) then the resulting delay is excused and liquidated damages will not be assessed. Whenever a contractor incurs liquidated damages, the precise counting of each day's delay based on these conditions directly affects the sum paid; therefore, it is worth making the calculation of delay in your contracts as clear as possible. When excusing construction delay caused by rainfall beyond normal, for example, you may specify in the contract what normal rainfall is and how the number of days of greater than normal rainfall will be computed. (Reviewed: August 21, 2009)
Q. If in the original contract there was not an agreed amount of liquidated damages discussed between the two parties, what amount can you impose on the contractor if the job is not finished in the allotted timeframe?
A. We cannot advise you properly without reviewing the actual terms of the contract. You should consult your counsel and the Federal agency you are working with. (Revised: August 21, 2009)
Q. Is there a legal limit to the maximum amount of Liquidated Damages to be applied? Example: Amount of Liquidated Damages shall not exceed 10% of the contract value. We are preparing a contract for construction of an aircraft maintenance hangar.
A. We are not aware of any legally imposed limit on Liquidated Damages. However, it makes sense to have a cap in the contract on the maximum amount of LDs that will be imposed, especially because of the difficulties that uncapped LDs may cause contractors when trying to obtain performance bonds. Sureties are wary of uncapped LDs and may refuse to bond the contractor or fix the bond premium at a high price, which will be passed on to the buyer. Excessive risk may also cause inflated bid prices as bidders seek to cover themselves for a worst-case scenario. LDs are discussed in the Best Practices Procurement Manual (BPPM), section 8.2.3 - Liquidated Damages.
Q. If the Liquidated Damages clause was a part of the original solicitation, can it be deleted on a contract modification? My federal experience is that Liquidated Damages cannot be waived at the local level.
A. The old FTA Circular 4220.1E, paragraph 13 - Liquidated Damages Provisions, gave FTA a legal right to funds collected pursuant to the Liquidated Damages clause. A similar provision exists in current FTA Circular 4220.1F. All such funds recovered are to be credited to the grant, thus reducing the Federal share as well as the grantee's share. To do otherwise requires FTA's approval. This principle of FTA having a legal interest in this clause would also extend, in our opinion, to any action to delete the clause after contract award. We do not believe a grantee could do this without FTA's approval. We would also be concerned with how this action would affect the integrity of the original competitive process. For example, if all bidders had known the Liquidated Damages clause would be deleted after contract award, would that have affected the amount of the bids and the resulting contract award? (Revised August 21, 2009)
Q. What is The FTA's definition of liquidated damages?
A. FTA has not published a definition of liquidated damages, but the definition that is included in the glossary of terms used by the National Transit Institute (NTI) in the courses that they teach on behalf of FTA is as follows:
A specific sum (or a sum readily determinable) of money stipulated by the contracting parties as the amount to be recovered for each day of delay in delivery of the product or completion of the contract.
The Best Practices Procurement Manual (BPPM) has a discussion of liquidated damages in Section 8.2.3, and there you will find the same definition of the term as used by NTI. (Reviewed: August 21, 2009)
Q. We have a draft contract with a transit service provider that contains a provision for liquidated damages. We plan to assess liquidated damages whenever the contractor fails to meet certain provisions. Are we permitted to apply any liquidated damages we receive from the contractor to help fund the contractor's employee pension plan?
A. The FTA Procurement Circular 4220.1F, Chapter VII, 4. b. (2) requires the grantee to credit all liquidated damages recovered to the project unless FTA agrees otherwise. You should contact your regional FTA office for their approval of your proposal. (Posted: July 2010)
Q. If we are recovering liquidated damages from a contractor that is is furnishing rolling stock, can we use the funds recovered to place a sole source order with the that contractor for spare parts, or do we have to compete the spare parts procurement?
A. If your rolling stock contract has no spare parts requirements, nor any options for them, then you would have to process the spare parts procurement as a sole source action. (Posted: August, 2013)