In a recent article published in Bizjournal.com we learn of a developer and owner of a historic commercial building in New York City who successfully avoids paying contractual delay penalties despite failing to deliver his project on time.
Michael Shaw a developer and property Owner in New York City faced hefty delay penalties for failing to meet an August 1, 2015 project completion date. Shaw was hired by his tenant Urban Outfitters to build out their store within Shaw’s building. Shaw failed to complete the work on time because of complexities associated with the historic landmark status of his building. As a resulted he did not complete the work until July 12, 2016.
Shaw’s tenant, Urban Outfitters included a clever delay clause into their lease which granted them rent credits for every day the project was delayed. The rent credits accrued at different rates depending on how long the project was delayed. The total delay accrued 825 days of rent credits for Urban Outfitters. At a lease rate of $100,000 per month, Shaw was on the hook for over $2.7 Million in rent credits.
Throughout my career I have encountered a number of Clients who have either requested or in some cases demanded that their contracts include penalties associated with delays in construction. Schedule delays are quite common in construction and often cause owners a great deal of angst.
The general rule has always been that in order for a delay clause to be enforceable, the penalties associated with the deal cannot be punitive. Punitive delay claims are unenforceable and are likely to be overridden by the courts.
For Shaw, the fact that a day for day rent credit was not tied to any loss of profit, caused the courts to find the penalty as punitive and therefore overrode the clause awarding Urban Outfitters just $650,000.
So what is an Owner to do to avoid extreme delays like the one experienced by Urban Outfitters?
Validate Your Schedule
The first thing I recommend for any Owner is to hire your own independent scheduler to validate your construction schedule.
One of the findings of the court in the case with Shaw is that the construction schedule was far too optimistic. In other words, there was no plausible way that an August 2015 date was achievable. Unreasonable schedule expectations are all too common in construction. Both Owners and developers are guilty of demanding and promising unreasonable durations which cannot be met. It is well worth the cost of an independent professional scheduler to validate that your completion date is achievable.
Consider Early Completion Bonuses
Early completion bonuses are generally a better option for incentivizing schedule.
Many Owners don’t like bonuses because they see this as additional expense, but if schedule is a priority for you, you are more likely to achieve an early (or on time) completion by offering a small bonus than you might be from imposing a penalty. To overcome the mindset that a bonus is an added expense, you need to look at the bonus as part of your base costs. One of the tactics I have used is to negotiate the initial price down a few percentage points and then offer the amount of the negotiated savings as the bonus. Be sure not to disclose that you are planning to offer a bonus until after you have negotiated down to the best price.
Spread the Wealth
If you do decide to offer a bonus, be sure to require the GC to split the bonus with Key trades.
Offering a bonus only to the GC does not incentivize the people actually doing the work. The key to successful bonuses is to incentivize your key trades. Your bonus clause should require the GC to split 50% (or some other significant percentage) of the bonus with one or more key contractors. Key contractors can be defined either by the value of their contracts or by trades who’s work is on the critical path on the schedule.
Don’t JUST Focus on Schedule
Make sure to split the amount of the bonus across multiple performance targets.
No matter how fast they do the work. there is no point in paying a bonus to a GC or trade contractor who cost you money from violations, accidents, or change orders. Be sure to incentivize good performance as well as fast performance by establishing targets for other valuable metrics. One example I’ve used has been 33% of the bonus value paid for zero accidents, 33% of the bonus value paid for zero rework, and 33% for less than 5% in change orders.
Establish Measurable Penalties
If late completion really will cost you a loss, calculate the actual costs.
In the end, you may still want (or need) to have a delay penalty. I certainly am not saying you should never use penalties, but when you do, be sure to tie the penalties directly to the actual expenses you will incur. This may take some work, but if you want an enforceable clause this is absolutely necessary. Consider the cost of rent, lost revenue, additional costs from operating an outdated or inefficient facility, energy use from less efficient building systems, and other operating costs. Be sure to spell these items out in your contract so the courts can clearly see that these are actual expenses and not punitive damages.
Ensuring that your construction schedule is met can be a challenge. It all starts with an achievable target. There is nothing wrong with having late completion penalties as long as they are based on actual expenses. Aim for a balanced approach by offering bonuses and penalties together and you may find that you get more bees with honey than you do with vinegar.
What approaches have you used to incentivize schedule? How successful was your strategy? Tell me your stories.
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