One for the LADs

Liquidated damages, otherwise known as liquidated and ascertained damages (LADs), are intended to compensate one party to a contract because of a breach by the other. In construction this is usually when the main contractor fails to meet the client’s completion date.

LADs are commonly referred to as “a penalty clause” which is incorrect and misleading as damages and penalties are, in fact, very different. If the courts consider an amount that is stated as LADs is actually a penalty then it may be that the claim will be unenforceable.

LADs have to be a genuine pre-estimate of the likely loss that the client will suffer in the event of late completion. The value of LADs is estimated, taking account of the loss of potential income such as rents and sales plus any costs such as prolonged interest charges payable on funding arrangements etc and then included in the contract particulars. This quantifies the contractor’s financial risk in the event of an unauthorised delay.

A penalty on the other hand, is an arbitrary sum included as a threat to encourage the contractor to perform and is not based on a ‘genuine pre-estimate’ of any potential loss. That said, the court might take the view that if two parties, familiar with construction contracts, have agreed to an amount of LADs then it should not disturb that agreement if the contractor then subsequently claims the value is too high and therefore a penalty.

Most standard forms of main contract allow for liquidated damages, albeit standard forms of subcontract do not. They are included to allow certainty of amount and simplicity of process. The contractor will know what it is liable for should it default and the client can set off that amount against any payment due to the contractor or claim it as a debt. However the client has the choice over whether to include LADs in the contract or leave damages “at large” ie to value the actual loss and expense following any breach; this is known as unliquidated damages.

LADs are something that a firm is most likely to meet when acting as a main contractor. They are triggered when the supervising officer certifies that the contractor has failed to meet the contract completion date. They are usually time related and, for example, may be at £500 per week or pro rata thereof. Therefore if the contractor finishes two weeks late and the supervising officer has certified this to be the case then the client is able to claim £1000 from the contractor.

It should be noted that such damages are not subject to the addition of vat, which is one reason why they are not usually included on a valuation certificate or payment notice. The procedure for doing this is that the client issues a withholding notice (as required by the Construction Act) stating that £1000 will be ‘set-off’ against an interim payment due to the contractor or alternatively claims against the contractor for that amount, which becomes a debt due to the client.

The situation is different in standard forms of domestic subcontract. DOM/1 and DOM/2 state that when a subcontractor fails to complete on time “...the subcontractor shall pay or allow to the contractor a sum equivalent to any direct loss and/or expense suffered or incurred by the contractor…” In other words, the contractor has the right to unliquidated damages. The JCT forms of subcontract, which are superseding DOM/1 and DOM/2, contain similar provisions. It is therefore very important for a subcontractor to inspect the terms of the contract agreement and note the value of LADs the main contractor may have to pay the client, before signing the subcontract.

If the subcontractor is solely responsible for causing a delay, then the main contractor is likely to claim that the contract liquidated damages represent part of the direct loss and/or expense suffered as a result of the subcontractor’s default and include them in the build-up of its claim.

As the value of LADs can be significant, the risk associated with entering into a subcontract should be weighed against the financial return the contract may bring. If this risk is disproportionately high the subcontractor would be well advised to either negotiate with the main contractor or decline the work.

Non-standard, or bespoke forms of subcontract, can include LADs, which may be applied even if the subcontractor’s delay has not caused an over-run to the main contract completion date. The issue of damages should be very carefully considered before entering into a contract.