336 Construction contracts
termination, less what it would have cost the contractor to complete the work. It has been clearly established that the damages should include the profit element on work remaining to be done.16 Where, however, the contract is one which the contractor had under-priced and on which the contractor would thus have made no profit, only nominal damages will be awarded for the employer’s breach. This is because an award of damages should not put the claimant into a better position than if the contract had been performed.17
20.2LIQUIDATED DAMAGES
As mentioned earlier, there is a special category of damages known as ‘liquidated damages’ (sometimes called ‘liquidated and ascertained damages’ or ‘LADs’). This term applies to a predetermined sum which becomes payable by a party to a contract if certain specified breaches occur. Where it exists, this type of entitlement replaces the normal right to claim damages measured by the amount of loss actually suffered.
20.2.1Nature and purpose of liquidated damages
A claim for ‘liquidated damages’ can only succeed where the contract makes express provision for it. Most construction contracts do this, by means of a clause providing that a contractor who is guilty of failure to complete the works by the contractual completion date (as extended where appropriate) shall pay or allow a certain amount of liquidated damages for every day or week of delay. Such clauses are found in JCT SBC 11 clause 2.32 (entitled ‘Payment or allowance of liquidated damages’); NEC3 optional clause X7 (referred to as ‘delay damages’) and FIDIC 1999 Red Book (referred to as ‘delay damages’). Provisions for recovery of liquidated damages are not limited to delays to completion. In optional clause X17, NEC3, for example, provides for recovery of liquidated damages due to poor performance of the completed plant or asset.
Liquidated damages provisions are in principle perfectly acceptable. Indeed, they are to be encouraged as they enable the parties to know from the start as much as possible about the risks they bear. They also save time and money on arbitration or litigation. However, the law recognizes that they are capable of operating rather harshly in cases where the amount to be paid or forfeited is greatly in excess of the loss caused by the breach of contract. Because of this, the courts have traditionally treated such clauses with a fair degree of suspicion. For example, the courts have always insisted that any contractual procedures are strictly adhered to and, in most cases, have interpreted any ambiguities against the employer.
It seems, however, that this strict traditional approach may have changed. In the case of Philips Hong Kong Ltd v Attorney-General of Hong Kong,18 the Privy Council emphasized the desirability of upholding freedom of contract, at least
16Wraight Ltd v P H & T (Holdings) Ltd (1968) 13 BLR 26.
17C & P Haulage v Middleton [1983] 3 All ER 94.
18(1993) 61 BLR 41.
Financial remedies for breach of contract 337
between contracting parties of equal bargaining strength. It thus appears that, unless consumers are involved or there is evidence of economic duress, the courts will henceforth lean in favour of enforcing liquidated damages provisions and will not seek to strike them down on technical grounds. In the High Court in London, in 2010, it was noted that, in a commercial contract, the court should normally uphold what the parties had agreed.19
The most important aspect of the courts’ control of LADs is their insistence that a ‘penalty clause’ (which means an attempt to terrorize the contractor into completing on time) is unconscionable and wholly unenforceable. In such circumstances the employer is left to claim unliquidated or general damages in respect of whatever loss or damage can be proved.
The difference in law between liquidated damages and a penalty is thus of crucial importance. Unfortunately, this is a difference of fact and degree rather than a difference of kind, and is thus difficult to express with any great precision. However, some assistance on the matter has been forthcoming from the courts. The most notable guidelines on distinguishing between liquidated damages and penalties, which have been long accepted as the best available, were given by Lord Dunedin in 1915:20
1.The terms used in the contract are not conclusive, though they may be persuasive.
2.Unlike a penalty, liquidated damages represent a genuine attempt at a preestimate of likely damage.
3.In deciding into which category a particular contract term falls, account must be taken of circumstances at the time of making the contract, not at the time of breach.
4.The following ‘tests’ may be helpful, or even conclusive:
If the sum stipulated is ‘extravagant and unconscionable’ compared with the greatest amount of loss that could be caused, it is a penalty.
If the breach consists simply of non-payment of money, and the sum stipulated is a greater sum, it is a penalty.
If a single sum is payable for a range of breaches of varying severity, there is a presumption (but no more) that it is a penalty.
The fact that an accurate pre-estimation of the likely damage is almost impossible to achieve does not prevent a stipulation from being classed as liquidated damages. In fact, it is in precisely these cases – public buildings, housing association projects and other non-profit-making ventures – when a liquidated damages clause is most useful.
As Lord Dunedin’s first guideline makes clear, whether or not something constitutes a penalty is a matter to be decided by the courts, not by the parties to the contract. For this reason, statements like all sums payable by the contractor to the employer ... shall be paid as liquidated damages for delay and not as a penalty
(ICC 11 7 clause 47(3)) will not have their intended effect at law. Similarly, express terms stating that the amount for liquidated damages is a genuine pre-
19Azimut-Benetti SpA v Darrell Marcus Healey [2010] EWHC (Comm).
20Dunlop Pneumatic Tyre Co Ltd v New Garage & Motor Co Ltd [1915] AC 79.
338 Construction contracts
estimate of the employer’s likely loss (ICC 11 clause 47(1)(a)) cannot take precedence over the guidelines.
In relation to the second guideline, it has been said that there must be a substantial discrepancy between the level of damages stipulated in the contract and the level of likely loss before a liquidated damages clause will be struck down as a penalty. However, the test of whether or not a pre-estimate is ‘genuine’ is an objective one and does not depend solely on the honesty of the party making it.21
The third guideline has encouraged contractors in some cases to argue that if, in certain hypothetical circumstances, a contract clause could have resulted in serious over-compensation for the employer, that clause must be regarded as a penalty. However, it has been made clear that the crucial test is what the parties might reasonably have expected to happen, not what might possibly have happened.22
Although the vast majority of the cases in this area have concerned stipulations for the payment of a defined sum of money, it is clear that other contractual stipulations may also fall foul of the ‘penalty’ rules. An example of this can be seen in a civil engineering case, Ranger v GW Railway.23 The contract provided that failure by the contractor to proceed regularly with the works would entitle the employer to forfeit all money due and all tools and materials. It also provided that, if this were not enough to cover the cost of completion, the contractor would be liable for the shortfall. It was held by the House of Lords that this provision was a penalty, since the value of the money and goods forfeited might far outweigh the cost to the employer of completing the work.
A similar decision was reached in Public Works Commissioner v Hills,24 where a railway construction contract provided that, in case of delay, the contractor should forfeit all retention money under that contract and two other contracts. Here it was pointed out that retention money naturally increases as time goes on, and thus bears no relation to the employer’s likely loss from delay – as a result, the forfeiture provision was to be treated as a penalty.
A third example of this principle is the case of Gilbert-Ash (Northern) Ltd v Modern Engineering (Bristol) Ltd,25 in which a sub-contract provided that, if the sub-contractor failed to comply with any of its provisions, all payment from the main contractor could be suspended or withheld. Once again, the provision was held to be a penalty, this time because a trivial breach could lead to the retention of a wholly disproportionate sum of money.
It sometimes happens that the amount of ‘liquidated damages’ agreed on by the parties is likely to be less than the employer’s actual loss. Where this can be seen from the outset, the clause in question operates as a kind of exemption clause (which are discussed in Section 10.2), since it effectively limits the contractor’s liability for breach of contract. This may bring into play the very complex rules governing exemption clauses, including (in theory) the provisions of the Unfair Contract Terms Act 1977. However, the way in which that Act is drafted means that it will only apply to liquidated damages clauses where either the employer is a
21Alfred McAlpine Capital Projects Ltd v Tilebox Ltd [2006] BLR 271.
22Philips Hong Kong Ltd v Attorney-General of Hong Kong (1993) 61 BLR 41.
23(1854) 5 HLC 72.
24[1906] AC 368.
25[1974] AC 689.
Financial remedies for breach of contract 339
‘consumer’ or the contract is made on the contractor’s ‘written standard terms of business’. In relation to JCT contracts, which are drafted following negotiations by all sides of the construction industry, it seems unlikely that a court would regard these as a contractor’s written standard terms.
20.2.2Operation and effect of liquidated damages clauses
In cases of delayed completion, the employer may seek to claim liquidated damages in accordance with the contract. To do this, the employer must show that:
1.The clause is not a penalty.
2.There is a definite date fixed by the contract from which the damages can run. As we have already seen, this date may be the completion date originally fixed or any other date that has been substituted under the provisions of an extension clause. In the latter case, the procedures for extending time must have been properly applied.
3.Any specified contractual procedures (such as a contract administrator’s certificate or the giving of written notice) have been complied with.
4.The employer has not waived the right to deduct liquidated damages.
Where all these conditions are satisfied, the employer will be entitled to claim or deduct the stipulated sum, irrespective of what loss has actually been suffered or, indeed, whether there has been any loss at all. Thus in BFI Group of Companies Ltd v DCB Integration Systems Ltd,26 a contractor was engaged under a JCT MW 80 form of contract to construct a warehouse. When the completion date arrived, the warehouse was almost completed, but still lacked its roller shutter doors, which had not arrived from the suppliers. The contractor allowed the employer to take possession and to fit out the warehouse and, by the time this had been done, the doors had been delivered and fitted. The employer had thus not lost any useful time, but was nevertheless held entitled to claim the full amount of liquidated damages provided in the contract.
A liquidated damages clause is said to be ‘operative’ where it applies and also where it would apply, but for a valid extension of time or an employer’s waiver of rights. Where this is the case, it represents the sole ground of claim; it is not open to the employer to disregard it and claim unliquidated damages at common law. In
Surrey Heath BC v Lovell Construction Ltd,27 for example, completion of the works was delayed by a serious fire, which was alleged to be due to the negligence of the contractor. The employer granted an extension of time to cover the effects of the fire, but then claimed damages from the contractor to cover the loss of rental income from the premises resulting from the delay. This claim, it was held, must fail; the employer’s losses were covered exclusively by the liquidated damages clause, which did not apply here because of the extension of time.
An even more striking example is Temloc Ltd v Errill Properties Ltd,28 in which the employer had inserted ‘£nil’ in the Appendix as the rate for liquidated
26[1987] CILL 348.
27(1988) 42 BLR 25
28(1987) 39 BLR 30.
340 Construction contracts
damages. It was held that this precluded any claim at all for late completion; since the employer’s normal right to seek unliquidated damages had been replaced by a right to seek no pounds for each week of delay! This seems a very odd result, and it may be noted that the position would almost certainly have been different if the whole liquidated damages clause had been struck out, or even if the Appendix had been left blank. In such circumstances, a court could have treated the liquidated damages provision as ‘inoperative’, in which case a claim for unliquidated damages would have been available.
An important practical consequence of the principle just illustrated occurs where there is a fluctuations clause in the contract, covering costs that increase at a time when the contractor is guilty of delay. In such circumstances the contractor, despite the delay, will be able to pass on these increased costs to the employer; the latter’s only remedy is to claim liquidated damages.29 However, it is of course possible for the contract to provide that a fluctuations clause shall ‘freeze’ when the contractor is in delay, and such provisions are indeed found in both JCT SBC 05 and ICE 7.
As stated above, an ‘operative’ liquidated damages clause provides the employer’s sole remedy for delay. By contrast, a clause that has become ‘inoperative’ for some reason will leave the employer with a perfectly valid breach of contract claim for unliquidated damages. These will be assessed so as to compensate the employer for whatever losses can be proved. It is for this reason that it may be in the employer’s interest, in cases where losses actually exceed the stipulated sum, to argue that the clause is in truth a ‘penalty’, since this would leave open the possibility of a claim for general damages. It also appears that an employer, who has rendered a liquidated damages clause inoperative (for example by causing a delay for which no extension can be granted), can resort to a common law claim.30 However, it is doubtful whether the employer would be allowed in such circumstances to claim more than would have been received as liquidated damages. If this were allowed, the employer would appear to benefit from his or her own breach of contract, and this is something the law does not usually allow to happen.
20.2.3Liquidated damages clauses in the main standard forms
The operation of the principles described above may be demonstrated by reference to the clauses found in the main standard form contracts. For example, clause 2.32 of JCT SBC 11 provides that, before liquidated damages can be claimed or deducted, the contract administrator must issue a non-completion certificate (certifying that the contractor has failed to complete on time) and the employer must give the contractor written notice of intention to deduct liquidated damages. If an extension of time is subsequently granted, it is still necessary for the contract administrator, on each occasion that a new completion date is fixed, to issue a fresh non-completion certificate, but the employer’s original notice of intention to deduct liquidated damages remains in force until it is specifically revoked.
29Peak Construction (Liverpool) Ltd v McKinney Foundations Ltd (1970) 1 BLR 111.
30Rapid Building Group Ltd v Ealing Family Housing Association Ltd (1984) 29 BLR 5, CA.