Beware of Liquidated Damage Clauses in Residential Construction

contract review


The Minnesota Court of Appeals issued its ruling today in Smart Construction, Inc. v. Dean Suchy, A22-1524. The case dealt with whether a liquidated damages clause was valid.

Background on Liquidated Damages

The homeowner in this case signed a contingent insurance restoration contract with the contractor. The initial insurance scope of loss was missing several necessary items to restore the property. The contractor sent two revised estimates, using Xactimate, to the insurance company. The insurance company agreed to pay $100,000.00 on the claim, but a revised scope of work was never issued. The homeowner chose to not have the contractor perform any of the work, and the contractor sued for breach of contract.

The clause in this contract was: "Customer’s cancellation, of this Contract after the recession period, if any or Customer’s failure to make available the work premises may result in breach of contract, remedied by Customer paying to SC&RI, an amount equal to 30% of the contract or Insurance Company’s Allocated amount plus costs of all materials as a reasonable amount of agreed damages, which are uncertain due to costs of storage, rescheduling and other undeterminable costs, which the parties agree to liquidate in advance of any dispute."

What are Liquidated Damages?

Liquidated damages (LD) clauses are regularly used in construction contracts. When the contract is created, they are agreed damages if one party breaches. Two common examples of LD clauses are:

  • a subcontractor that has to pay a specific dollar amount per day if they are behind schedule, and
  • a percentage of a contract amount in the event of a breach.

If the damages from a breach are very difficult to determine, the LD clause can't be "manifestly disproportionate" to the actual damages. If the damages can be determined, the LD clause can't be "greatly disproportionate" to the actual damages. Put more simply, if it's almost impossible to figure out what the damages might be when the contract is created, the clause can't create a huge financial benefit for the party that didn't breach. If it's possible to figure out what the damages could be when the contract is created, the clause needs to be pretty close to the actual damages.

The Legal Findings

At trial, the contractor did not put any evidence of its out-of-pocket costs, time spent on the claim, or what the expected profits would have been. The jury awarded the contractor $30,000.00 on its breach of contract claim. Following the jury verdict, the district court found that expectation damages, as opposed to liquidated damages, “can be reasonably calculated and determined on the breach [of contract claim].”

In other words, the court held that the contractor could have kept track of expenses and time it spent working on the file to determine actual damages. Additionally, because the contractor used an Xactimate breakdown showing its profit and overhead, the lost profits were also known. Because of this, the district court held the liquidated damages clause was an unenforceable penalty. This meant the contractor was not entitled to recover any money. The contractor appealed.

The Court of Appeals agreed with the district court’s findings. It found that the calculation of damages “would not require speculation given Smart’s ability to establish lost profits as a fixed percentage and its ability to keep track of its efforts to negotiate that claim.” The contractor would have gotten more money for the breach than if it had completed all the work. Because of that, the Court of Appeals affirmed the finding and the contractor recovered nothing.

What You Should Do

  1. Review your breach of contract clause to see how damages are calculated.
  2. Keep track of your time and expenses when working on insurance restoration claims.
  3. Hire an experienced construction law firm to make sure you get paid.

Contact North Star Law Group at 651-330-9678 to find out what this case means for you and whether your contracts put you at risk of not recovering your money.

Categories: Construction