Here is an unanswered question from "Ask A Professor." Does anyone disagree with my answer?

Subject: Liquidated Damages
Posted to Architect-Engineer and Construction Contracting on 2/7/01 by XXX
The Scenario
Assessment of liquidated damages on a Construction Contract.

"The Question
I have always been told that funds reimbursed to the Government as a result of assessment of liquidated damages must go back to the General Treasury Account and may not be deposited back into the construction funds account. When liquidated damages are assessed may they be deducted from the contract price and used to procure additional work, provided the funds have not expired?"

"The Answer: No answer available at this time"

Joel's answer: If liquidated damages are actually physically collected from a contractor, in the form of a check or draft, what you always heard may be correct. However, if the L.D.'s have been held as some type of retainage from progress payments, in an amount sufficient to protect the Government's interest, there won't be a problem.

Upon resolution of the issue, the funds retained from payments are converted to "L.D.'s", then de-obligated from the contract amount. At that time, the de-obligated funds may be returned to the appropriation for other valid uses of that funding.

It is the policy of the Corps of Engineers to retain funds from progress payments on construction contracts to protect the Government's interest, when it becomes apparent that a contractor is running behind schedule, without a valid excused delay. If we properly manage the progress payment procedures, there should be sufficient retainage from payments to cover L.D.'s, should it ultimately be decided to assess them.

The key to this is not to be put in the situation where you must collect overpayments from contractors.

Anybody disagree? Happy Sails! Joel

By Anonymous on Wednesday, February 21, 2001 - 07:43 am:

I don't disagree with the way you treat LDs, because I would do the smae thing in your situation. However, I don't believe that is the proper technical answer. LDs are supposed to be payments from the contractor to the government for harm created by contractors delays in performance. In other words, the government incurs some financial harm by the contractor being late, and LDs are a means to compensate. What you are doing is almost like receiving a credit from the contractor to be applied against payments. In other words, the contractor isn't receiving full contract amount. That's not LD, where the payment for harm may not immediatly be due to the contract itself - like the government is paying rent until the contract is finished. LDs properly should be cash payments to the governement and not be confused by contract payments.

By joel hoffman on Wednesday, February 21, 2001 - 09:07 am:

Anon, where did you learn this? "That's not LD, where the payment for harm may not immediatly be due to the contract itself - like the government is paying rent until the contract is finished. LDs properly should be cash payments to the governement and not be confused by contract payments."

I have an "ENG Form 93" for payments to construction contractors, dated "Mar 78", two years before I started working for the Corps of Engineers. This form provides for deductions from contract payments to cover liquidated damages. Once L.D.'s are "assessed", the deductions are taken from the contract amount and separately accounted for as L.D.'s.

I've been administering contracts and payments to contractors since 1980, using this prescribed method. I wasn't aware that the Government should be paying the contractor, without any retainage, when it fails to maintain satisfactory progress, then "hope" it can pay the Government back L.D.'s, some day. I disagree with your assertion and request a source for this idea.

In my experience, most L.D.'s have been assessed against contractors which encountered severe financial difficulties, resulting in lack of payment to subs and suppliers and resulting delays or terminations. Happy Sails! Joel

By Anonymous on Wednesday, February 21, 2001 - 10:11 am:

I was thinking in general terms and ignored use in construction where LDs are assesssed for fauilure to pay subs. However, in more general use, LDs are used in the situation I described such as the government incurring losses (see examples cited in FAR 11.503(b)). As far as how LD payments are treated, look at the GAO Red Book. I don't have immediate acess to ne right now, but I will look when I get a chance.

By joel hoffman on Wednesday, February 21, 2001 - 10:55 am:

Anon, My discussion of the subject only concerns construction L.D's, as described in Subpart 11.5 - damages for late completion.

I couldn't find anything in the GAO Redbook, however will endeavor to research the Army Regulation for finance and accounting, when time permits. The question is how do we account for l.d's deducted from payments due a contractor.

I have three points.

1) When a contractor is behind schedule, without excused delays, and appears not to be able to complete on time (current COE policy is 30 days or 5% behind schedule), the Government has the right to hold reasonable retainage from progress payments. See Clause 52.232-5 Payments Under Fixed Price Construction Contracts, paragraph (e)Retainage. This is done to protect its interest, in the event that there will be liquidated damages assessed. If the contractor regains schedule, the Government can release the retainage.

2) Upon determination that there was an unexcusable delay in completion, this retainage may be converted to assessed L.D's, and/or other undisbursed contract funds may be used for assessment of L.D.'s.

3) The Government doesn't have to actually receive a payment from the Contractor to collect the assessed L.D's. It can be deducted from the final payment due the contractor.
Happy Sails joel

By Anonymous on Wednesday, February 21, 2001 - 11:21 am:

Joel
Your answer accurately describes what most construction offices do....but it actually violates appropriations laws. Anon was on the right track. Please let me try to explain. You work for a very very small agency. You have received 100,000 for 1 construction project. It takes two months and the contractor was fifteen days late. He paid all his bills there was no punch list and he owes us 2000.in LD. Now here is why the LD clause is written the way it is. If he pays you the LD as the clause requires then he is entitled to full contract payment. So you have expended the 100k and you are holding a $2000. check. If you used it for other work you have clearly enhanced your appropriations" Now you are in a position to spend a total of 102,000. That's 2000 more than Congress gave you. And that cannot be done. It must be sent back to treasury. By deducting it from a contractors payment you would be foiling the intent.

By anon 2 on Wednesday, February 21, 2001 - 11:23 am:

Thats anon 2 at 11.21

By Anonymous on Wednesday, February 21, 2001 - 11:31 am:

Joel,

You should be ok, particularly with contruction to do it the way you currently are. My point, and again this is a technicality, is LDs are PAYMENTS from the contractor. The clause even states "the Contractor shall pay to the Government as liquidated damages...". Note this doesn't mention anything about offsets, etc. Also because LDs are used when damages "the amount is difficult or impossible to ascertain or prove", most fiscal people take the position that these need deposited to Treasury as misc receipts and agencies cannot keep since there is no tie to actual reimbursement.

By joel hoffman on Wednesday, February 21, 2001 - 11:57 am:

Anon2, you have valid concerns about actual use of such funds for additional work. I need to review the accounting and finance regulation for disposition of retained l.d.'s. By the way, funds disposition is not determined by the construction offices. In the past the COE Finance and Accounting offices made the transactions - now done by DFAS. I beleive that Anon1 and I were primarily debating the administrative details of "collecting" the L'D's. However, I did state in my initial post that I thought the de-obligated funds could be used for other valid uses.

I would agree that a cash payment received by the US from a contractor generally goes into the US Treasury (exceptions for foreign military sales cases funded by the host country).

It has been my understanding that the Government could use retainage ultimately deducted from monies due a contractor to offset additional administrative costs incurred, which are also funded out of the same type appropriation. If the additional costs were caused by the Contractor, the question is, "can this funding source pay for those additional costs?"

However, other damages, such as user's indirect and direct costs, off-base rental costs, etc. are often funded out of other appropriations than the contract type funds(unless the contract is funded with O&M funds). Then the question would relate to augmentation of one fund with another source.

Good questions, indeed.
Happy Sails! Joel

By joel hoffman on Wednesday, February 21, 2001 - 12:02 pm:

Anon1 (11:31AM), you may be right about what happens to the funds, even if not directly received from the contractor and that LD's are not a precise measure of the Government's actual damages. I have to review the F&A reg. Happy Sails Joel

By John Ford on Wednesday, February 21, 2001 - 12:25 pm:

Joel, I think your analysis is correct. If the contractor does make a payment to the government, it should be deposited into the miscellaneous receipts account at the Treasury. Obviously, the agency gets no use of that money.
At one time it was DoD policy to manage debt collections, such as liquidated damages, in such a way as to maximize DoD's ability to get the most out of each appropriation. I believe that is still DoD's policy. Retainage and deobligation is one way of achieving that policy. In case the retainage is not sufficient, when the contractig officer imposes liquidated damages upon the contractor, the government can resort to self help if it has other contracts with the contractor and offset liquidated damages due under one contract against payments due under another. This also allows the agency to utilize the "LDs" and not pay them over to the Treasury.

By John Ford on Wednesday, February 21, 2001 - 12:47 pm:

I have to disagree with Anon2 (11:21) about the augmentation of appropriations. In the example given, under Joel's scenario, the agency would have retained the $2000 and not paid the contractor. The contractor would only have been paid $98K. This leaves the agency with only the $100K Congress appropriated. Clearly, use of the $2k in this case would not be an augmentation of appropriations. In this case, the contractor pays the LDs by a price reduction in the contract. This same result could have been achieved by the government extending the period of performance after receiving consideration, in the form of a price reduction, for not terminating the contract for default due to the contractor's unexcused delay in performance. This is another way of maximizing your appropriations and ensuring contract performance.

By joel hoffman on Wednesday, February 21, 2001 - 01:32 pm:

Thanks for the information, John. I have someone researching AR 37-1 but found this excerpt from Engineer Regulation 37-345-10:  Accounting and Reporting - Military Activities CH 1-52 (pages 7-30a to 7-31) Change 39, 29 Nov 85
"7-14. Lump-sum and Unit Price Contract Work.  …d. Damages (specific or liquidated damages) and other charges
assessed contractors or sureties for extra casts to the Government will  be accounted for as provided herein.  

(1) Some examples of extra costs to the Government are:  

(a) S&A costs, such as for: added inspection time; replacing stakes and other marks destroyed by contractor; retesting materials  after failure to meet requirements in initial test; and review of shop drawing after rejection of initial shop drawing.
(b) E&D costs of additional reviews required to meet performance standards of construction design effort and for additional engineering supervision of contract E&A, resulting from delinquent performance by contractors.
(c) Costs for terminating defaulted contract and completing facility or service by other contract or Government forces.
(d) Other costs resulting from delinquent performance by contractors, such as for: providing substitute facilities; standby
time of technicians; and storage of equipment.
 

(2) Pending final determination by the contracting officer, the amount of damages (actual or liquidated) assessed contractors for failure to complete the contracted work within the time specified by the contract, damages withheld under the terms of the contract should be carried as accounts payable. Upon final determination, accounts payable will be liquidated and damages assessed will be credited to project cost accounts as follows.

(a) Damages finally assessed in connection with E&D will be credited to account 800.4.
(b) Damages assessed for extra S&A costs and liquidated damages assessed under the Work Hours Act of 1962, other than such damages assessed against contractors performing construction to which the Corps-wide S&A rates apply, will be credited to account 802.3.
(c) Damages assessed against contractors performing construction to which the Corps-wide S&A rates apply will be credited to account * 465.802.3 or 466.802.3.
(d) Assessments for other kinds of extra costs to the Government chargeable to funds administered by the District Commander will be credited to the accounts which include such costs.
(e) Assessments for extra costs to the Government, but chargeable to other than funds administered by the District Commander, will be credited to account 956.
(f) Damages accounted for as above will be treated as an offset against engineering supervision or supervision and administration costs, as applicable, and not as a reduction of contractors' earnings."

Happy Sails! Joel

By anon 2 on Wednesday, February 21, 2001 - 03:30 pm:

At the risk of becoming pedantic I know what the practice is within the government I am just trying to say that it is wrong. JF --if you retained 2k and paid 98k technically you owe congress the 2k--it is not available for other projects. JH--I cannot comment on the info provided because it is not fully contextual but my initial reading suggests that the liquidated damages mentioned are related to DB violations not LDs at 52.211.11 However I cannot say for sure. But using LD under DB as an example--if you used retainage to acquire them are they free for you to use? The red book at page 6-108 in the second and third paragraphs make it clear as to how monetary credits (retainage and offset) are to be treated.. And they are treated as cash. And for what it is worth just because we deposit funds to the treasury does not mean we cannot recover them.The reason the procedures are generally not followed is because the amounts involved are small ,by comparison, and therefore do not attract attention. But I hope you will agree with me that it is at least appropriate to know the rule we break. Nes Pas?

By Anon 1 on Wednesday, February 21, 2001 - 03:52 pm:

Anon 2,

I couldn't agree more. I started to say the same thing but didn't. Another reason the procedures aren't followed is there are no losers. Money going back to Treasury doesn't do the agency any good.

By joel hoffman on Wednesday, February 21, 2001 - 11:12 pm:

Dear Anon 2, you are slightly correct. There are a myriad of different "damage" situations covered by this regulation. This paragraph of the regulation, among other things, discusses the disposition of "Liquidated damages", where the contract includes an LD provision for late completion. It also covers delay damages where the contract does not include an LD provision, as well as other types of damages. The COE can only use these funds to cover the additional costs, such as supervision and administration (S&A), engineering and design (E&D), etc. when caused by a contractor - not for additional work. Since salaries, travel, office space, etc. are strictly reimbursible costs, they are truely "increased costs" due to completion delays. The COE isn't funded like an O&M organization or other standing organizations.

The Department of Labor makes labor deduction determinations, not the COE. I believe we send any offsets or labor fines and deductions to DOL.

Dear Anon1, I'd bet your next pay check that this "very small agency's" fiscal regulations comply with fiscal law, DOD, and Army Fiscal regulations.
Happy Sails! Joel

By John Ford on Thursday, February 22, 2001 - 10:46 am:

Anon2, you say it is important for us to know the regulation we break. I agree. My problem is no one has identified the regulation at issue.  On another note, I have a major problem with the idea that retainage and offsets must be treated as amounts to be credited to the misc. receipts account of the Treasury instead of being added back to the appropriation from whence they came. For example, amounts received under the credits cost principle in FAR 31.201-5 and its companion provision in the Allowable Cost and Payments clause, are credited back to their original appropriation and are available for future use to the same extent as are other amounts in that appropriation. Similarly, amounts credited to a contract under the Progress Payments provision when material is transferred from that contract are credited back to the original appropriation. As for retainage, when the government retains fee under a cost type contract, and the contractor does not deliver all that it has contracted for, the retained fee is deobligated off the contract and credited back to the original appropriation. Finally, contract debts collected as an offset under FAR 32.6 go back into their original appropriation account and are treated as other balances in that account.

A good example of the operation of credits is the California sales and use tax refund matter of a few years ago. For years, California had improperly been collecting a use tax on property used on government contracts. This resulted in a refund to contractors covering eleven years of taxes. Under the credits cost principle and the Allowable Cost and Payment clause, the government was entitled to a credit for amounts it had paid the contractors for those taxes. The ultimate amount of the refunds would exceed $450M. Because most of the appropriations used on the contracts under which the taxes had been reimbursed had been canceled, the government collected the refunds as lump sum cash payments from contractors and deposited them into the misc. receipts account. However, if the appropriations had still been available, the refunds would have been collected as adjustments to specific contracts and credited back to specific appropriations and retained by the agencies concerned, primarily DoD and NASA.

By Anon 1 on Thursday, February 22, 2001 - 12:37 pm:

John,

I think the point everyone is missing is that liquidated payments are not credits, they are payments the contractor is supposed to make to the government. Take a look at the language in the clause and my prior post. The clause says nothing about credits or offsets.

By joel hoffman on Thursday, February 22, 2001 - 01:19 pm:

"(f) Damages accounted for as above will be treated as an offset against engineering supervision or supervision and administration costs, as applicable, and not as a reduction of contractors' earnings."

Anon, I don't quite understand what point you are trying to make. The LD clause doesn't need to address the "mechanics" of how the damages are collected. The above accounting regulation recognizes that actual "earnings" are not reduced. The Contractor still "earns" 100% of the contract amount.

However, we can mechanically take an offset against "payments" by reducing the amount of the electronic transfer to cover damages. Are you saying we can't do that?

By Kennedy How on Thursday, February 22, 2001 - 01:48 pm:

Anon1,

If you're correct in that they're actually payments, we (the Government) is converting it TO a credit because we'd lose the money if it was paid back. This is why when you return something to a store, you get a credit, and not cash. The money stays with the transaction partners.

In the case we are talking here, the regulation tells us that the payment has to be made to the US Treasury. At that point, we (the obligating activity) loses the money. In the big picture, it's a punishment to the contractor for screwing up, and maybe for the contracting/manager activity for letting it get screwed up.

I know that when I used to administer weapon systems contracts, whenever the contractor owed us money, he hated to have to cut a check (it looks bad on their books). We hated it too, because we get penalized for saving money (this was the vast majority of the reasons why the contractor owed us money). So, we used the amount owed as a credit against some future service/action. Because if we had insisted the contractor cut us a check, it'd go to the Treasury, and Army had already told us our program wasn't going to get any more money than they had already given us.

And, we weren't happy. (Note that at no time was there a requirement by law or regulation to have a cash payment submitted to the Government.)

Kennedy

By Anon 1 on Thursday, February 22, 2001 - 02:22 pm:

Kennedy,

I totally agree. I implied earlier that it's not a big deal, and keeping the money for agency use isn't ilke commiting a crime. My point is technically liquidated damages in most cases are not for finite amounts of the actual damages incurred. Consequently (no pun intended), monies paid the government other than reimbursement in eaxt amounts, cannot ke kept - they go to Treasury. Agencies receive appropriations based on budget submissions. Keeping funds, other than what are authorized by law or for certain kinds of reimbursements, is improper and supplements appropriated funding.

By joel hoffman on Thursday, February 22, 2001 - 02:31 pm:

Anon 2, a clarification. Technically, the Corps of Engineers is not an "agency". It is a major command within the Army. True, it is considered a "contracting agency". This year's budget is somewhat over $11 billion, down somewhat from a few years ago, when the cold war military construction portion of the budget was two or three times the current value. The COE has 36,000 civilian and military employees (mostly civilian), not counting "military engineers" and troops. When I started, the number was about 70-75,000 employees, but privatization, commercialization and downsizing hit. Happy Sails! Joel

By ANON 2 on Thursday, February 22, 2001 - 03:04 pm:

I think we are all in violent agreement but I would like to point out one truth. When we send, iaw appropriations rules, money to treasury we are not hurting our budget in the next FY. In other words doing the right thing does not puinish us in this particular case. ANON 1 2:22 IS RIGHT.

By John Ford on Friday, February 23, 2001 - 10:13 am:

Anon 1 12:37, I agree that LDs are not credits. My comments were directed toward the earlier reference to the GAO Red Book to the effect that retainage and offsets were to be treated in such a way that they are considered misc. cash receipts.
A question for Joel, when the Corps recovers LDs on work which was funded by another agency, what does the Corps do with those funds?

By Kennedy How on Friday, February 23, 2001 - 12:28 pm:

I also think we are agreeing violently, but I also think that some folks may be mistakenly thinking it's all a big shell game or accounting exercise. I think that part of the problem stems from the amount obligated vs the amount demanded in payment by invoking LD. If you don't change the amount obligated, then there is a case of extra appropriation. There may also be an erroneous understanding of the practical situation at hand if the contractor hasn't been fully paid under the contract. Many folks believe it's more practical to withhold money than to have a contractor pay it back, because getting a contractor to pay it back means a dogfight.

Kennedy

By anon 2 on Friday, February 23, 2001 - 02:26 pm:

KH
I agree it is easier but the practice defies ordinary contract admin. If a contractor owes LDs why would anyone liquidate the contract total before acquiring monies owed? As I said earlier if the LDs were greater than the final payment someone has failed to properly administer the contract. In my opinion ,unless there is statutory authority to do otherwise, I would withhold final payment until the LDs had been paid by the contractor. As I am sure you know claims work both ways. And as to JFs comments let me offer this clarification--the red book says that monetary credits are treated as misc receipts and what I guess I find difficult to accept is to convert MRs to appropriations. But I do know we do it.

By joel hoffman on Friday, February 23, 2001 - 03:32 pm:

John, This is in response to your 2/23/01 question concerning funds. Unfortunately, our USACE home page and our server with the technical documents (ER 37-345-10) is off-line, today. I will research your question, as soon as I can.

I assume you are speaking of at least three separate topics on customer funded projects (which are generally all but Civil Works funded contracts). As you may know, "liquidated damages" are pre-determined for each proposed contract, prior to advertisement. There is often a customer component, and there is always a COE component of the total LD amount. I will check what account(s) the LD's go into.

For other types of damages, I will review the account numbers referenced above for a description. On all customer funded projects, when the project and contract is fiscally closed, I believe all excess funds are returned to the customer organization or as directed by the F&A rules. As I said before, labor violation damages are sent to DOL, or wherever directed by DOL.
Happy Sails! Joel

By Anonymous on Monday, February 26, 2001 - 09:16 am:

I am curious, what is the reportable contract price (at closeout) of the example contract provided by Anonymous on 2/21/01 (11:21)? $98K, $100K, or $102K?

By Anon1 on Monday, February 26, 2001 - 09:38 am:

$100K. The contractor is paid the full contract price and writes a check for $2,000 in liguidated damages for performing late.