In the case of Atlantic Erectors, Inc. v. Court of Appeals and Herbal Cove Realty Corporation, the Supreme Court ruled that a contractor can be held liable for liquidated damages due to project delays, even if the construction contract was prematurely and illegally terminated by the project owner. This means that contractors must diligently fulfill their contractual obligations within the agreed timelines, as failure to do so can result in financial penalties, irrespective of how the contract ends.

Unfinished Business: Can a Contractor Pay for Delays When a Contract is Cut Short?

Herbal Cove Realty Corporation hired Atlantic Erectors, Inc. to construct townhouse units in their subdivision project. The contract stipulated a completion period, with liquidated damages for delays. Atlantic Erectors encountered delays, and Herbal Cove eventually terminated the contract, citing poor workmanship and lack of commitment. Atlantic Erectors contested the termination, arguing it was not given a fair chance to complete the project. The central legal question revolves around whether Herbal Cove could claim liquidated damages from Atlantic Erectors, given that the contract was terminated before the project’s completion.

The Construction Industry Arbitration Commission (CIAC) initially ruled that while Atlantic Erectors was indeed delayed, Herbal Cove’s termination of the contract was illegal due to a failure to provide the required 15-day notice. Consequently, the CIAC did not award liquidated damages to Herbal Cove. However, the Court of Appeals (CA) modified this decision, asserting that Atlantic Erectors could still be charged with liquidated damages because the delay in completing the project was a separate issue from the legality of the termination. This distinction is crucial, as it underscores that the right to claim liquidated damages arises from the contractor’s failure to meet the agreed-upon deadlines, regardless of how the contractual relationship is ultimately severed.

The Supreme Court affirmed the CA’s decision, emphasizing the dual nature of liquidated damages. According to Article 2226 of the Civil Code:

Article 2226. Liquidated damages are those agreed upon by the parties to a contract, to be paid in case of breach thereof.

Liquidated damages serve as both compensation for losses incurred due to delays and as a deterrent against breaching contractual obligations. The Court highlighted that to claim liquidated damages, the project owner must demonstrate that the contractor was indeed in default of their obligations. This means that the contractor failed to complete the work within the agreed timeframe, or any validly extended period. The Court referenced Articles 2227 and 2228 of the Civil Code, which discuss the conditions under which liquidated damages can be equitably reduced or not applied, emphasizing that the specific breach contemplated by the parties must align with the actual breach committed.

In analyzing the construction contract, the Supreme Court noted that the agreement explicitly stipulated the payment of liquidated damages for delays. Article IX of the contract stated:

Section 1: The CONTRACTOR acknowledges that the OWNER shall not suffer [loss] by the delay or failure of the CONTRACTOR to finish and complete the works called for under this Contract within the time stipulated in Section 6, Article IV. The CONTRACTOR hereby expresses covenants and agrees to pay to the Owner liquidated damages equivalent to the One-Tenth of One Percent (1/10 of 1%) of the Contract Price per calendar day of delay until completion, delivery and acceptance of the said Works by the OWNER to a maximum amount not to exceed 10%.

The Court also emphasized that Herbal Cove’s right to recover liquidated damages was distinct from its right to terminate the contract. Even if the termination was deemed unlawful, Atlantic Erectors’ liability for damages due to delays remained valid. As stated in Article 29.04 of the contract, “Neither the taking over by the Owner of the work for completion by administration nor the re-letting of the same to another Contractor shall be construed as a waiver of the Owner’s rights to recover damages against the original Contractor and/or his sureties for the failure to complete the work as stipulated.” This provision clearly establishes that the owner’s actions to mitigate damages by completing the project themselves do not negate their right to seek compensation for the contractor’s initial failure to meet deadlines. Moreover, the conditions for any extension of time had to be agreed upon in writing.

The Court cited previous cases to support its stance, reinforcing the principle that parties are bound by the stipulations in their contracts, provided they are not contrary to law, morals, good customs, public order, or public policy. Atlantic Erectors failed to complete the works within the originally agreed period and the subsequent extension. While Atlantic Erectors claimed additional delays were caused by factors beyond their control, they did not properly seek additional extensions as required by the contract. The Court observed that Atlantic Erectors proposed completing the project significantly beyond the extended deadline, demonstrating a clear failure to meet their contractual obligations.

The Supreme Court concluded that Atlantic Erectors was liable for liquidated damages up to the maximum amount stipulated in the contract, which was 10% of the contract price. The Court found no reason to reduce this amount, considering that Atlantic Erectors had only completed a portion of the project at the time of termination. This ruling underscores the importance of contractors adhering to project timelines and following proper procedures for requesting extensions. It also clarifies that project owners can pursue claims for liquidated damages even if they terminate a contract, as long as the contractor was in default of their obligations.

FAQs

What was the key issue in this case?	The key issue was whether a contractor could be held liable for liquidated damages due to project delays, even if the construction contract was terminated unlawfully by the project owner.
What are liquidated damages?	Liquidated damages are damages agreed upon by parties in a contract, to be paid in case of a breach. They serve as compensation for losses and as a deterrent against breaching contractual obligations.
What did the Construction Industry Arbitration Commission (CIAC) initially rule?	The CIAC initially ruled that the contract termination was illegal due to the project owner’s failure to provide the required notice, and thus did not award liquidated damages.
How did the Court of Appeals (CA) modify the CIAC decision?	The CA modified the decision by stating that the contractor could still be charged with liquidated damages because the delay in completing the project was separate from the legality of the termination.
What does the Civil Code say about liquidated damages?	The Civil Code allows parties to stipulate liquidated damages in case of breach (Article 2226), and provides for equitable reduction if they are unconscionable (Article 2227). If the breach is not what was contemplated by the parties, the law determines damages (Article 2228).
What was the contractor’s argument in this case?	The contractor argued that it was not given a fair chance to finish the works due to the project owner’s actions, and should therefore not be liable for liquidated damages.
What did the Supreme Court decide?	The Supreme Court affirmed the CA’s decision, holding the contractor liable for liquidated damages because the delay in completing the project constituted a breach of contract, irrespective of the termination’s legality.
What is the practical implication of this ruling?	Contractors must diligently fulfill their contractual obligations within agreed timelines, as failure to do so can result in financial penalties even if the contract is terminated.

This case serves as a crucial reminder of the importance of adhering to contractual obligations, particularly in construction projects. Contractors must ensure they meet deadlines, follow proper procedures for requesting extensions, and maintain clear communication with project owners. Failure to do so can result in significant financial liabilities, regardless of the circumstances surrounding the contract’s termination.

For inquiries regarding the application of this ruling to specific circumstances, please contact ASG Law through contact or via email at frontdesk@asglawpartners.com.

Disclaimer: This analysis is provided for informational purposes only and does not constitute legal advice. For specific legal guidance tailored to your situation, please consult with a qualified attorney.
Source: ATLANTIC ERECTORS, INC. vs. COURT OF APPEALS AND HERBAL COVE REALTY CORPORATION, G.R. No. 170732, October 11, 2012