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There have been significant decisions on liquidated damages in the last couple of years which we consider in this insight.

Liquidated damages, also sometimes referred to as ascertained damages, are a familiar feature to those dealing with construction contracts. There have been significant decisions on this topic in the last couple of years.

Why use liquidated damages?

Liquidated damages (LDs) are a fixed, pre-determined sum (usually a stipulated sum per day or per week), agreed between the parties to a contract to apply in the event of a breach of contract. Liquidated damages commonly apply in the event that the contractual dates for sectional completion and/or practical completion of works on a project are not met.

Having liquidated damages agreed in advance means that each party knows where they stand on the question of loss if a breach occurs. The alternative to liquidated damages is that general damages might be claimed, which then requires the party claiming the loss to provide evidence and substantiation of the loss.

As it was succinctly put by the Supreme Court in the Triple Point case (discussed further below), liquidated damages bring advantages to both parties:

“74. …….. First, establishing what financial loss delay has caused the employer would often be an intractable task capable of giving rise to costly disputes. Fixing in advance the damages payable for such delay avoids such difficulty and cost. Second, such a clause limits the contractor's exposure to liability of an otherwise unknown and open-ended kind, while at the same time giving the employer certainty about the amount that it will be entitled to recover as compensation. Each party is therefore better able to manage the risk of delay in the completion of the project.”

Drafting liquidated damages clauses

Many standard form construction contracts, such as the NEC and JCT forms, are drafted to allow for the inclusion of LDs. Unlike the NEC form, the JCT form requires the employer to take additional steps before being able to offset or claim LDs. This includes service of a Non-Completion Notice and notice that the employer intends for the contractor to pay LDs or for them to be deducted. Both the NEC and JCT standard forms contracts, in the event that an extension of time is granted, allow for a repayment of the relevant proportion of LDs previously deducted.

Liquidated damages are usually interpreted as being an exclusive remedy for loss in the event of the relevant breach occurring. Careful consideration should therefore be given to the rate of LDs to be deducted and evidence kept of these considerations. Otherwise, if losses are subsequently considered to be greater than as set out in the relevant LDs provision, there may be no right to seek additional compensation.

It is a commonly-known potential bear trap that if a contract provides for liquidated damages, but a decision is taken that they are not to be applied, the contract should clearly state that the relevant clause “does not apply” or is ”not applicable” such that the ability to claim general damages is preserved. To leave the option blank, or worse include a rate of £0, may have the unintended consequence of suggesting that it is agreed that there is to be no loss claimed in the event of breach/delay.

Where there is a contractual chain, liquidated damages provisions should be interrelated, and flow through, with each subordinate contract addressing the cost of breach/delay including any LDs that may be payable in the superior contract.

It is also advisable to include provisions dealing with how LDs will reduce following any sectional completion/partial possession. As discussed below, there have been a number of unsuccessful challenges on this point in recent case law, but it is still sensible to make provision for this.

Further, it is important to ensure that any connected contractual provisions are properly drafted and complied with. For example, it is important that a contractual programme is agreed and regularly updated.

Many LDs clauses are applied without issue. When disputes do occur, this is commonly because one party asserts that the LDs clause (or a cap on LDs) is not valid or enforceable.

There have been a number of court decisions in recent years and, from that, it can be seen that the court’s approach to LDs clauses is to generally seek to enforce the clause. This is because they have usually been commercially negotiated, often with external legal representation, and the court’s view in such circumstances is that the parties are best placed to determine what damages should apply. We now consider some of the exceptions to this rule.

Penalty clauses

The courts may step in if LDs are clearly disproportionate to the loss/damage actually suffered. Traditionally, the burden has been on the challenging party to prove the clause is a “penalty” with the argument being run as to whether or not the LDs claimed were a “genuine pre-estimate of loss”.

More recently, the courts have shown that they prefer to take a more commercial view, and have, in effect restated the test as being one of whether the remedy is disproportionate to the legitimate interest it is intended to protect (although the genuine pre-estimate test remains a useful reference point).

The most significant decision on this topic was the Supreme Court Decision in Cavendish Square Holdings BV v Talal El Makdessi [2015] UKSC 67. At paragraph 255 of the judgment, Lord Hodge summarised his views as follows:

“255. I therefore conclude that the correct test for a penalty is whether the sum or remedy stipulated as a consequence of a breach of contract is exorbitant or unconscionable when regard is had to the innocent party's interest in the performance of the contract. Where the test is to be applied to a clause fixing the level of damages to be paid on breach, an extravagant disproportion between the stipulated sum and the highest level of damages that could possibly arise from the breach would amount to a penalty and thus be unenforceable. in other circumstances the contractual provision that applies on breach is measured against the interest of the innocent party which is protected by the contract and the court asks whether the remedy is exorbitant or unconscionable.”

See our insight on the above case 'LADs and penalty clauses – important reading for all associated with the construction industry'.

Caps on liquidated damages

Can an unenforceable LDs clause, which provides for a cap, still operate as a stand-alone cap on damages for delay? This has been long debated with differing outcomes, depending principally on the reason for the finding for the unenforceability of the LDs provisions and the particular drafting of any cap. We consider some of the most recent key cases on this topic.

Whilst not a hard and fast rule, the decisions indicate an inclination towards:

  1. Where LDs appear to be a penalty, the LD cap will operate as a general cap on damages i.e. the party who sought to benefit from an alleged penal provision will also be restricted by that provision; or
  2. Where LDs are unenforceable due to uncertainty, there would need to be clear drafting to evidence that the cap was in fact intended to apply to general damages.

In the case of Eco World – Ballymore Embassy Gardens Co Ltd v Dobler UK Ltd [2021] EWHC 2207 (TCC) the court considered whether the LDs provision was void for uncertainty because the contract did not properly cater for the effect on LDs where there was a partial possession/sectional completion. The court, reflecting the more commercial approach, found the provision was not void for uncertainty. Further, as outlined above, it found that the agreed LDs provision anticipated that, even if that clause was unenforceable in relation to LDs, the same clause which contained a cap would act as a cap on general damages. Weightmans’ Chris Doran has considered this topic previously.

Most recently, in the case of Buckingham Group Contracting Ltd v Peel L&P Investments and Property Ltd, the court had to consider again (1) whether the contractual LDs provisions were void/unenforceable for uncertainty; and (2) whether the contractual cap on LDs should apply to general damages. It was alleged that the LDs were void because of there being uncertainty with multiple completion dates such that the rate of LDs to be applied could not be set out with certainty. It was also argued that the LDs provisions failed to deal with what would happen in the event of partial possession. The court decided the LDs provisions were valid. In addition, whilst no decision on the issue was required, comments were made by the judge that it may be possible for a cap on LDs to operate as a general limitation on other liabilities even if the LDs are not enforceable. Whether that is the case, however, will depend on the scope of the cap and therefore the drafting. In this case the cap was referred to as a “cap on maximum LADs” and there would likely be no wider application of that cap. However, it can immediately be seen that this decision presents potential conflict with the decision in Eco World.

These decisions reiterate that courts will enforce negotiated LDs clauses where possible. However, they also demonstrate that there is uncertainty as to whether a cap on LDs can act as a cap on general damages. Given the uncertainty, from the employer’s perspective, it will want to ensure by clear drafting that if an LDs provision is found to be void, that it will not act as a cap on general damages. Conversely from the contractor’s perspective, if an LDs cap is in fact intended to have a wider effect in the event of unenforceability, this should be clearly set out for the avoidance of any doubt.

LDs and termination

The trio of decisions, very aptly the Triple Point decisions, provide the latest court guidance on liquidated damages in a termination setting.

Triple Point Technology Inc was engaged by PTT Public Company to design, install and maintain a software system. Payment was to be made on completion of certain milestones, some of which were not met. PTT refused to make further payment. Triple Point suspended work and in response PTT terminated the contract. Triple Point issued a claim for unpaid invoices and PTT counter-claimed, relying on the LDs provision in the contract.

The relevant clauses of the contract were:

Article 5.3:
"If [supplier] fails to deliver work within the time specified and the delay has not been introduced by [customer], [SUPPLIER] shall be liable to pay the penalty at the rate of 0.1% (zero point one percent) of undelivered work per day of delay from the due date for delivery up to the date [customer] accepts such work, provided, however, that if undelivered work has to be used in combination with or as an essential component for the work already accepted by PTT, the penalty shall be calculated in full on the cost of the combination”.

Article 12:
"… The total liability of [supplier] to [customer] under the contract shall be limited to the contract price received by [supplier] with respect to the services or deliverables involved under this contract. … This limitation of liability shall not apply to [supplier's] liability resulting from fraud, negligence, gross negligence or wilful misconduct of [supplier] or any of its officers, employees or agents."

At first instance, Triple Point was found to have been in breach of contract. The court decided that PTT was entitled to claim LDs and damages for wasted costs and a replacement system. The LDs were not subject to a cap but the other damages were.

On appeal, the Court of Appeal held that the LDs were only due in respect of those works that had in fact been completed late and not the remaining works which were not completed due to the termination. It also held that both the LDs and the general damages due on termination were subject to the overall cap on liability.

The case was then referred to the Supreme Court which in particular had to consider whether LDs could be enforced, notwithstanding that, because of the termination, the customer could not be said to have “accepted” the works. The Supreme Court allowed LDs to be claimed and again showed it would strive to uphold the commercial reality of an LDs clause.

Conclusions

In conclusion:

  1. LDs are a potentially useful tool for both parties to a contract;
  2. Careful drafting is required to ensure LDs are enforceable and have the implications intended, especially in respect of any cap;
  3. For LDs to work as intended, the parties need to be aware of, and operate, related contractual provisions e.g. conditions precedent and programme updates; and
  4. Where there is any dispute as to the enforceability of LDs, the court’s policy is generally to seek to find them enforceable. It is therefore very important to ensure that the clause drafting is clear and precise.

If you would like further guidance around liquidated damages, please contact one of our expert construction and engineering solicitors.