Is it permissible for my father to deduct an amount from the contractor after the contract period expires, given a prior agreement on the percentage of deduction in case of delay? And is he obliged to compensate the heirs of the deceased contractor for his loss in selling the land that he gave him in lieu of the deducted amount?

The penalty clause in contracting agreements is permissible according to the preponderant opinion. Your father has the right to deduct the amount he did from the agreed-upon sum with the contractor, especially since the latter consented to it. What your father did by giving the plot of land to the contractor to absolve himself of liability is a good deed. He is not obligated to compensate the contractor for any decrease in the land's value unless he intended to donate it.