Liquidated Damages in Construction Contracts
Liquidated Damages in Construction Contracts
Introduction
As inconvenient as it may be, delays happen in construction projects. Weather, supply chain issues, and unexpected conditions can all push a construction schedule off track. When this happens, every day of delay can create real financial consequences for owners and added pressure on contractors who are trying to deliver the project. Having a solid plan in place before work starts, to understand how the parties will be impacted due to delays is advantageous in protecting yourself under the contract.
Liquidated damages clauses can help both sides by establishing clear expectations up front. But not every clause is enforceable. Texas courts closely review these provisions to ensure they reflect fair compensation, not punishment.
What Are Liquidated Damages?
Liquidated damages are pre-agreed monetary damages tied to delays or other specific breaches. Instead of calculating the actual damages months or years later, the original contract sets a reasonable estimate of what a delay or breach could cost.
Common uses include:
Delays in reaching substantial completion
Missed milestones affecting revenue or occupancy
Breaches that risk operational disruption
When done correctly, liquidated damage clauses encourage timely performance, simplify dispute resolution, and help avoid costly and uncertain litigation about actual damages. The goal is to estimate and agree to damages before a dispute ever arises. However, if the amount of liquidated damages is inflated, arbitrary, or unrelated to real loss, a court may refuse to enforce the clause as an improper penalty.
When Are Liquidated Damages Enforceable in Texas?
In Phillips v. Phillips (1), the Texas Supreme Court established a two-prong test for determining whether a liquidated damages clause is enforceable.
To be valid, the party seeking to enforce the clause must prove that at the time of contracting:
The harm caused by the breach must have been difficult or impossible to estimate; and
The liquidated damages were a reasonable forecast of just compensation.
In a construction project, delay-related damages can be uncertain due to fluctuating rents, lost use of a facility, variable overhead, and other changing market conditions. This unpredictability typically allows owners to meet the first prong. However, the second prong requires actual business-based reasoning in calculating the value of liquidated damages, not a random or one-size-fits-all figure.
The Second Look at the Time of Breach
The Texas Supreme Court later clarified that courts must take a second look at the time of breach to ensure the clause still represents fair compensation (2). Simply put, Texas courts must now ensure that there is not an “unbridgeable discrepancy” between liquidated and actual damages.
Under this second look review, a party trying to enforce the clause must show the two-prong test is satisfied at the time of contracting.
However, even if the enforcing party is successful in meeting its burden, the party seeking to avoid paying liquidated damages may nevertheless avoid enforcement by proving that:
Actual damages turned out to be significantly lower than liquidated damages, and/or
The non-breaching party failed to mitigate their damages
If the party wanting to avoid the clause proves there is a material disconnect which cannot be justified, the clause becomes a “penalty clause” and will not be enforceable in Texas, despite having been agreed upon by the parties.
Examples From Recent Decisions
Enforceable
Provisions have been upheld where both Phillips prongs and actual versus liquidated damages revealed the provision to be enforceable (3).
Not Enforceable
Provision awarded twelve months of gross receipts regardless of the nature of breach (4).
Provision required payment of $20,000 in the event of termination. (Was “one size fits all”) (5).
Lack of evidence of actual damages suffered created an “unbridgeable discrepancy” between actual and liquidated damages (6).
Practical Drafting Tips
For Owners
Provide a reasoned and realistic estimate of damages at the time of drafting
Ensure damages provide an adequate recovery in the event of delay or breach
Retain documentation of how damages were calculated
Consider lost profits, construction loan fees/financing expenses, lost rent, additional management or overhead costs, and penalties for late occupancy
Avoid “industry standard” or prior agreements absent tailoring to each specific project.
For Contractors
Include provisions in subcontracts that pass through liquidated damages in proportion to subcontractors’ responsibility for delays
Cap total liquidated damages
Include a time period before liquidated damages begin to accrue
Avoid cumulative liquidated damages
Include an early completion bonus
Clearly define delays, milestones, and trigger events
Conclusion
Texas courts enforce liquidated damages when:
Damages were hard to estimate at the time the contract was signed, and
The liquidated damages value was reasonably based on expected harm, and
Actual damages fall in line with that original forecast after breach occurs
Liquidated damages can be a fair and efficient way to allocate risks, but only when they are grounded in a reasonable forecast proportional to the actual harm suffered. Understanding both the two-prong Phillips test and the Atrium second look rule helps owners and contractors draft effective and enforceable liquidated damages clauses.
Whether you are developing a construction project, negotiating a new contract, or facing a dispute over delays, understanding how liquidated damages work under Texas law is essential. Our firm can help you review contract terms, assess risk, and protect your interests every step of the way. If you need guidance on a current or potential construction matter, contact us today.
1. 820 S.W.2d 785 (Tex. 1991).
2. Atrium Med. Ctr., LP v. Houston Red C LLC, 595 S.W.3d 188 (Tex. 2020).
3. BMB Dining Services (Willowbrook), Inc. v. Willowbrook I Shopping Ctr. L.L.C., No. 01-19-00306-CV, 2021 WL 2231258 (Tex. App.—Houston [1st Dist.] June 3, 2021, no pet.).
4. Tempo Transp., LLC v. J.W. Logistics Operations, LLC, No. 05-22-01035-CV, 2024 WL 3311144 (Tex. App.—Dallas July 5, 2024, no pet.).
5. Diana Garcia, Appellant v. Dallas County Hospital District (d/b/a Parkland Hospital), Appellee, No. 05-23-01295-CV, 2024 WL 5251994 (Tex. App.—Dallas Dec. 31, 2024, no pet. h.).
6. Shops at Legacy (RPAI) L.P. v. Del Frisco's Grille of Tex., LLC, No. 05-19-01274-CV, 2020 WL 4745548 (Tex. App.—Dallas Aug. 17, 2020, pet. denied).