Minimum damage: Liquidated damages

In today’s climate, with employers trying to save money and contractors having to fight for every penny, disputes over liquidated damages abound. So what are the facts about the enforceability of these clauses and what are the areas to watch out for?

First, it is important to put the record straight: the level of damages is unlikely to be successfully challenged on the basis that it is too high. Both parties voluntarily signed up to this level, and commercial parties’ freedom to contract is rarely interfered with.

It is also irrelevant that the actual losses on delay could be much less than LADs – an issue that is particularly pertinent now that properties are proving difficult to let. The level of LADs in these circumstances may therefore give the employer a bit of a windfall.

On the other hand, if the works cannot be completed because of some matter for which the employer is responsible – for example, it is required to give possession by a certain date or another contractor has to install plant first – enforcing a LADs provision will be a problem.

In this case, contractors should look out for whether the extension of time clause allows the employer to reset the completion date if these matters cause delay. A reference to “other causes beyond the contractor’s control,” is insufficient to allow the resetting to take place (Wells vs Army & Navy Co-operative Society). If resetting the completion date is not possible, liquidated damages may not be recoverable in this situation.

What happens if the employer wants early possession or handover of parts, but there is no sectional completion clause? Recovery of liquidated damages may not be possible if the damages are contractually indivisible. Contractors should also beware clauses that state damages can be re-calculated with reference to the part not yet handed over, rather than the whole project. The contract should specify how you allocate contract value between parts taken over and those still in the possession of the contractor.

It may be simpler to apportion damages in a standard JCT contract than a civils contract. For example, the method of recalculating reduced LADs in NEC3 is with reference to any benefit to the employer rather than contract value.

The level of damages is unlikely to be successfully challenged on the basis that it is too high. It is also irrelevant that the actual losses could be much less than LADs

So what are the consequences if the LADs clause is unenforceable? It’s worth thinking about this before mounting a strong argument to this effect. Is it in your favour or to your detriment? If it is an act of prevention that has led to the liquidated damages clause being unenforceable, then time is arguably at large and the obligation to complete within a reasonable time then arises. Although the completion date has gone, it is still likely that original durations and programmes will be used as a base, at least in calculating what is a reasonable time.

While completing within a reasonable period may be desirable for the contractor, the next question is what happens to claims for prolongation? If there is no fixed completion date, the extension of time clause is not workable or necessary. While an extension of time award does not automatically lead to loss and expense, it does usually set the period for claiming prolongation costs. Contractors should consider whether they think there is an entitlement to increased preliminaries to complete within a reasonable time on the basis that this is greater than the original contract period. If so, the time period they might be recovered over needs to be specified.

The benefit of an extension of time clause is that time lost through employer risk events is clearly allocated. That will not be the case where the obligation is to complete within a reasonable time.

If the clause is unenforceable, what happens to the part that provided that liquidated damages were to be the sole measure of compensation for the employer in the event of delay? The employer may have lost the right to claim general damages in the event that the contractors fail to complete by the completion date. However, if only part of the liquidated damages clause fails, the employer’s rights may not be lost entirely.

What about caps on liability? Very often liquidated damages are capped at a percentage of the contract price. If the provision is unenforceable and general damages are applicable, are these subject to the same cap? General authority, although mixed, tends towards the view that if you lose the provision you lose it in its entirety including cap. Ironically this may have a consequence whereby the employer can benefit by its own act of prevention if it had a cap it now wishes to ignore.

So it’s not as simple as saying the clause is unworkable and time is “at large”. The consequences need to be considered carefully.