Liquidated Damages: What are They and What's the Right Amount?

Introduction

I can almost guarantee that most people’s liquidated damages amount in their domestic building contract is not right, and usually too low. I’ve seen it over and over again - most builders use the “standard” amount of $250 per week, and owners don’t know enough to ask the question, or builder’s don’t even ask the owner what their losses could be.

But what are liquidated damages and why are they in the contract at all?

What are Liquidated Damages?

Liquidated Damages (also widely known as ‘LDs’) are an agreed amount of money that one party pays the other in the event of a loss under a contract. In the context of a domestic building contract, that loss may arise for example, when the builder takes longer to finish the building works than they had anticipated – usually beyond the agreed completion date. This is why LDs in the context of building are sometimes called “delay damages” (there is a legal concept of general delay damages which is different than liquidated damages, but not that relevant for this purpose).

Under the Domestic Building Contracts Act 1995 (Vic) (‘DBCA’), the builder must state the anticipated completion date – described as “the date when the work will be finished, or, if the starting date is not yet known, the number of days that will be required to finish the work once it is started” (see section 31(1)(i) of the DBCA).

LDs are used as an award of money if one other party does not meet their contractual obligations. But the amount of the LDs should not be a penalty, and should be a genuine pre-estimate of losses. We will discuss what’s a genuine pre-estimate of loss a bit later on, but a penalty can be easy to spot, especially if the amount is out of proportion, extravagant or unconscionable within the context of the interest protected by the contract.

Why are LDs Included in Contracts?

It’s important to know that LDs are not a requirement of the DBCA, but it is customary for LDs to be included in construction contracts as a way to ensure that the project has a completion date that the builder is incentivised stick to. It also has a practical effect, because generally a breach of contract (eg. a delay) can be compensated for by damages. It’s just that an agreed amount saves a further dispute in the event that a breach such as a delay occurs.

We should also note that the standard HIA and MBAV contracts make provision for LDs to be paid from the homeowner to the builder as well. This scenario may arise if the owner delays the project without good reason, for example by failing to pay a stage payment or failing to select a certain fixture on time. Check your specific contract for the definition of when LDs apply, and discuss this with a construction lawyer if you are unsure.

What's an appropriate amount for LDs?

Of course, this depends on your situation.

You should work out your potential losses if your builder fails to complete your home by the completion date in your contract. How is this done in practice?

The amount of the LDs should cover losses such as rent, travel and other out-of-pocket expenses. You can estimate these costs by working out your weekly costs at the point the completion date elapses. For example, if you are paying $600 per week in rent whilst awaiting your home to be completed, then you should include at least $600 per week as LDs. Some people think that it should include both rent and mortgage payments for the time after the completion date. Whilst this may be the case in limited circumstances, most people will have to pay the mortgage on the house if they were to move in by the completion date anyway, so that isn’t a loss that can be included for LDs. The loss would usually be for the continuation of the rental costs or other costs that you wouldn’t normally have paid, but for the delay by the builder.

Tips for Working Out Your LDs Amount

If you are struggling to work out your LDs amount, a good starting point is the out-of-pocket expenses that you’d have to pay that doesn’t include any amounts that you would pay once the works are complete.

Remember though, it must be a reasonable estimate of your expected loss and not extravagant or out of proportion. If the amount is not in line with your potential loss, this could create further dispute and delays in payment.

LDs for Owner’s Delays

A typical scenario is that the builder will set the LDs to $250 per week for their delay, and $250 per week for the owner’s delay – that is, the amounts are equal. If you negotiate a higher amount for a builder’s delay, they builder may expect that the LDs for the owner’s delay is also increased. However, there is no reason why the LDs for the owner’s delay should be equal to the LDs for the builder’s delay.

Simple Negotiation Tactics

As a homeowner, one simple way to negotiate this with a builder is to ask what their estimated costs are for a delay before you negotiate your LDs amount. In other words, you should try to get them to state their genuine pre-estimate amount of loss for your delay, AND ONLY THEN should you try to negotiate the LDs amount payable to you. If the builder says that their estimated losses are $250 per week, that should not change even if your estimated losses are $600 per week.