Liquidated Damages Clause

Why should you consider the liquidated damages clause for real estate projects?
Well, when building a new home (or renovating your existing one using some of the fantastic ideas on Don Pedro Brooklyn), there’s a lot on the line.

You’re probably spending a good chunk of change on the project and would like it to be done on time, to the desired specifications.

But what happens when things go wrong — when a contractor fails to deliver in the way they promised?

You have a number of tools at your disposal. One of these is the liquidated damages clause, and today we’re going to explore when it’s relevant — and how to have an informed conversation with your lawyer and contractors about it.

But first…

Liquidated Damages Meaning: What is it?

When installing a luxury swimming pool like this one, a lot can go wrong — a liquidated damages clause could protect you from financial damages; Source: Creative Commons

The liquidated damages clause is a common precaution built into legal contracts. It allows one side of the contract to seek a predetermined sum from the other as a penalty for breach of contract.

In the context of this article, liquidated damages in a contract look like this.

You hire a contractor to complete renovation or construction work on your home. They fail to do so in the manner expected. If a provision for liquidated damages in the contract exists, you can act on the clause and seek compensation for losses you incur as a result of their failure.

You can find more info about the meaning of the liquidated damages in other contexts — but for the purposes of this article, we’ll be exploring this one.

Building the Liquidated Damages Clause Into Your Home Renovation/Building Contract

There are minutiae regarding how the liquidated damages clause works depending on your situation’s specifics, including your location.

Generally, however, it only makes sense if your situation is such that you would incur a financial loss (as opposed to mere annoyance) by your contractor’s failure to complete the work as outlined.

The sum you receive (or variables such as a percentage of the contract value, etc) would be determined at the time of the contract’s creation. It would generally be a fair estimate of the actual losses you’d incur.

Let’s look at a specific example of the meaning of the liquidated damage in this sense.

Liquidated Damages in Real Estate Example #1

A liquidated damages clause could protect you from financial loss if your wood flooring contractor breaches their contract; Source: Creative Commons

Say you’re in the business of buying homes, fixing them up, and then renting them out.

You buy a property and hire a contractor to replace the floors — but there is a serious delay in them completing the work. As a result, you aren’t able to rent the home out for an extended period of time.

If your legal agreement with the contractor contains a liquidated damages clause that accounts for such a situation, you can seek damages.

Let’s look at another example.

Liquidated Damages in Real Estate Example #2

Mid-Century modern kitchen design is great — but building one can turn into a nightmare without a liquidated damages clause; Source: Nicolas Boullosa, Creative Commons

Say you’re in the process of selling your home. You plan to use the proceeds from that sale to buy your next residence.

But a contractor hired to complete a mid-century modern kitchen renovation on your existing home fails to meet their end of the deal.

As a result, a buyer you had lined up bails. You’re unable to fund your next purchase and the seller comes after you for defaulting on your agreement with them.

If you have relevant provisions for liquidated damages in the contract with your renovator, you may be able to seek compensation.

As mentioned earlier, provisions for liquidated damages in a contract have many variables. There are location-specific nuances that you have to keep in mind, as well as context-specific ones.

For this reason, it’s key that you work with a lawyer to craft your contract. They can help you create a contract relevant to your situation.

As with many legal matters, trying to navigate liquidated damages in real estate on your own can be a disaster.

One thing you’ll inevitably have to broach on your own, however, is warming your contractor up to the idea of implementing this clause.

Convincing Your Contractor to Implement Liquidated Damages in the Contract

Contractors are often hesitant to agree to liquidated damages in real estate projects. They may see such a clause as overwhelmingly unfavorable to them.

Perhaps they fear you’ll interpret the clause liberally and come after them for damages in the case of what they might see as a reasonable delay.

Perhaps one of the most useful strategies for communicating the win/win nature of a liquidated damages clause is as follows.

Consider what would happen if there was no provision for liquidated damages in the contract and something went wrong. You would then be in a position to sue the contractor — and things would get messy from there.

They’d have to involve lawyers and may end up paying more than the liquidated damages clause would have necessitated.

Remember, a liquidated damages clause allows for reasonable compensation based on a pre-estimate of losses.

In a lawsuit situation, financial compensation may extend well beyond what any party would consider “reasonable” based on the actual damages the breach of contract caused.

Think of it like a prenup — something that’s relatively easy yet saves both parties a ton of headache trying to sort through numbers down the road. It’s even easier than a prenup, though, since the same degree of emotions isn’t involved.

Conclusion

By now, you should understand the meaning of the liquidated damage in the context of a real estate renovation project.

Be sure to work with your lawyer to craft a clause that makes sense and protects you. If your contractor refuses to agree to such a clause, consider explaining the benefits we’ve outlined above to them.

If you have a lot riding on the project and stand to incur significant financial losses if things go wrong, you may even wish to look elsewhere for a contractor that will agree to such a clause.

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