Construction / 2 min read
If you work in the construction industry, you’ve seen, heard, or experienced in some way, shape, or form, liquidated damages. Simply put, liquidated damages are contractually agreed damages assessed in the event of a breach. In the construction context, liquidated damages are typically a pre-determined measure of an owner’s damages for late completion of work.
Love them or hate them, liquidated damages are familiar, and parties so frequently use them (and get into disputes about them), that Texas courts have developed extensive rules around their enforceability and limitations.
A similar concept, but one that most are not as familiar with, is economic disincentives. Section 49.271(e) of the Texas Water Code is unique among Texas statutes in that it authorizes certain governmental districts defined in the Water Code to include economic disincentives in construction contracts for late completion of work.
Like liquidated damages, economic disincentives are often used in construction contracts, typically expressed as daily monetary rates for delay, and assessed for late completion of work.
On their face, Section 49.271(e)’s economic disincentives look, sound, and may even seem to act like well-known and loved (or hated) liquidated damages. However, there are key differences between the two.
First,
liquidated damages are used on all kinds of construction projects, including public, private, commercial, and industrial projects. You name the type of project, there is likely a liquidated damages provision in the associated contract. Virtually any party who could suffer harm by late completion and any party performing construction work can agree to a liquidated damages provision.
The availability and use of economic disincentives are much more limited than liquidated damages. Economic disincentives should only appear in the narrow context of construction contracts for district facilities or improvements where a district is a party to the contract. In Hanover Insurance Co. v. Binnacle Development, LLC, a developer attempted to use Section 49.271(e)’s economic disincentives in construction contracts for paving and infrastructure projects.
After analyzing the developer’s arguments based principally on statutory phrases and definitions, the U.S. Fifth Circuit Court of Appeals held that Section 49.271 allows economic disincentive clauses only in contracts where an entity meeting the Water Code’s definition of a “district” is a contracting party. In Hanover, because no district was a party to the contracts, economic disincentives could not be incorporated into the contracts.
Second,
because liquidated damages are so widely used in the construction industry, they are subject to well-developed judicial rules and limitations on enforceability. More specifically, liquidated damages must be a reasonable forecast or estimate, made at the time of contracting, of the actual damages the non-breaching party will suffer in the event of a delay. In addition, courts scrutinize them “after the fact”, i.e. for whether the assessed or assessable liquidated damages are out of reasonable proportion or represent an “unbridgeable gap”, when compared to the delay damages actually suffered. Based on anti-forfeiture principles, liquidated damages that constitute a penalty are unenforceable.
On the flip side, as confirmed by the Fifth Circuit in Hanover decided January 12, 2023, it appears that no Texas appellate court has construed the Texas Water Code economic disincentive provision. Thus, the extent of power or authority granted by the Texas legislature via the provision and any limits to the enforceability of economic disincentives clauses included in district contracts are not as defined as the law of liquidated damages. This difference in the law of liquidated damages and economic disincentives is perhaps the biggest and most important one.