Liquidated damages clauses in construction contracts
What are liquidated damages?
Most forms of building contract include a clause entitling the Client to a specified level of damages, referred to as “Liquidated Damages” or “Liquidated and Ascertained Damages” if the Contractor is late in handing over the building. LADs replace the Client’s common law right to damages for late completion with a contractual right to a pre-determined sum for the period of delay.
Advantages of LADs to Client
The amount of LADs is agreed in advance, so avoids the Client having to calculate and prove the actual loss. It also concentrates the Contractor’s mind on finishing the project on time.
Advantages to Contractor
In a tender situation, it makes fixing the contract price more certain, since the Contractor can price the level of LADs into his tender bid.
Also, if the project is behind schedule, the Contractor can make a commercial decision as to whether it would be preferable to hand the building over late and to pay the LADs or to devote more resources to the project to bring it back on time. Finally, the level of LADs specified is a ceiling for the amount of damages payable; if it turns out that the Client’s loss is greater than the LADs stated in the contract, the Client cannot claim the greater sum.
Types of LAD provision
LAD provisions are usually expressed as a certain sum payable for each day, or week or part of week by which practical completion is delayed. Other types are a straight lump sum, a fixed percentage of the contract sum or a maximum rate which reduces as part or parts of the project become available for occupation and use.
LAD clauses and penalties
It has long been the case that if a clause for LADs has been included as a penalty for late completion, rather than a genuine pre-estimate of loss, then the courts will not enforce it. However, just because the level of LADs specified in a contract is substantially higher than the loss actually suffered does not necessarily make the LADs clause invalid as a penalty. The courts do not require that the level of LADs payable should equate to the actual loss suffered by the Client, merely that the figure in the contract was a genuine pre-estimate of loss at the time the contract was entered into. If this was the case, but circumstances changed in between the date of the contract and the entitlement to LADs arising, so that the loss suffered by the Client is significantly less than the LADs provided for in the contract, the clause remains enforceable.
To take an extreme example, if the Contractor is late in completing a project, and the Client can satisfy the court that the amount specified in the contract for LADs was a genuine estimate of likely loss, then the LADs are payable by the Contractor (or, more likely, deductible by the Client from future payments), even if the Client has suffered no loss.
Attitude of the courts
The courts have always been wary of contractual LAD provisions and the clauses are interpreted against the party seeking to rely on them. Hence there is still a steady stream of cases involving contractors desperately trying to avoid being caught by such clauses by arguing that they constitute a penalty and are, therefore, unenforceable. However, while the courts interpret such clauses strictly, and ensure that the party seeking to enforce them have complied with them to the letter, the courts will not interfere unless the clause was oppressive. Where two parties have freely entered into a contract, the courts are reluctant to step in unless the contract is in some way unconscionable.
Genuine pre-estimate of loss
The key for the Client is to be able to show that the figure in the contract for LADs was a realistic estimate of the likely loss which the Client would suffer if the Contractor was late in achieving practical completion. The Client’s chances of defeating an argument from the Contractor that the LADs clause constitutes a penalty are considerably improved if the Client can show how he arrived at the figure in question, with calculations, projections etc, taking into account such factors as loss of income and increased financing costs. As stated above, the estimate needs to reflect the position at the time of the contract, not at the time when the claim arises. The more detail that the Client can produce to substantiate his figure, the better.
LADs and extensions of time
Building contracts almost invariably contain clauses entitling the Contractor to an extension of the contract period in certain circumstances (e.g. exceptionally adverse weather conditions, damage by fire, changes to the specification requested by the Client – “Relevant Events” in the JCT 1998 forms of contract). In such cases, the date for practical completion is moved back by the agreed period of extension, so the question of LADs would not arise unless and until the works were still not completed by the revised date for practical completion, and not the original one.
Provision for LADs unenforceable
If a court decides that an LADs clause is unenforceable, this does not mean that the Client is then precluded from claiming damages from the Contractor for delay. The Client would merely have to rely on his common law right to damages for breach of contract (i.e. for the Contractor’s breach of contract for failure to complete the project on time.
For more details on this topic or on any other construction law issues, contact Graeme Roberts on 0118 952 7246
Consistent with our policy when giving comment and advice on a non-specific basis, we cannot assume legal responsibility for the accuracy of any particular statement. In the case of specific problems we recommend that professional advice be sought.