https://morrisseylaw.com.

au/liquidated-damages-vs-delay-damages/

Liquidated Damages vs Delay Damages: What is the difference?

Where a contractor fails to complete works by the date for completion the typical
expectation is that such a breach would allow the principal to claim damages calculated as
the actual loss resulting from the delay to completion.

Alternatively, the contract may allow for the contractor to claim damages for delay caused
by the principal, or in some cases a wide range of events that are not of their causing (such
as wet weather).

The principle of damages for delay (which is what liquidated damages are) has a few
elements that need to be understood:

First, the construction project must have a contract.

Second, that contract must have a date for when the works are to finish, commonly the
date for Practical Completion.

Third, the contract needs to include a mechanism to claim liquidated damages or delay
damages.

What are liquidated damages?

Liquidated damages (LDs) are those which set a rate under the contract that applies in the
event a particular breach of the contract occurs. The idea behind this is that it removes the
need to prove an entitlement to damages at general law. Most commonly, liquidated
damages are for the owner, principal, and head contractor.

What are delay damages?

Delay damages (as they are commonly known) are still a form of liquidated damages but
are usually the defined term used by contractors in claiming damages. They are most
commonly used when seeking damages arising from the principal’s delay.

While LDs are able to be applied to any breach in respect of which a genuine pre-estimate
of the losses suffered may be made, the most common breach to which LDs apply is the
failure of a contractor to reach completion in the stated time.

Why are damages clauses so important?

LDs clauses are of critical importance for principals (or for down the line contracts
between head contractors and subcontractors) as they provide:
A clear and defined consequence for the contractor if it fails to carry out work efficiently,
and thereby achieve practical completion on time; and

A right for principals to claim compensation at an agreed rate for their genuinely estimated
loss incurred as a result of certain delays.

LDs clauses, believe it or not, are also beneficial for contractors, as they allow the parties
to apply a pre-determined rate of damages and avoid costly and time-consuming dispute
resolution processes arguing about what the actual damages are.

LDs clauses also provide contractors with a means to limit their liability in the event
delays occur, by including a cap on the amount claimable.
Delay damages clauses are also critical. The contractor must consider what is a reasonable
genuine pre-estimate of loss if the works are delayed.

Contractors should be methodical and considered in calculating the amount to be included

in a delay damages amount.

How to calculate a liquidated damages amount

When calculating an amount to be paid in the event of a breach, developers, principals and
head contractors should consider:

The interest cost on the funded amount of the project (per day);
The lost opportunity cost (either renting or sale (per day);
Any employee expenses,
And many other project-specific risks.

How to calculate a delay damages amount

When calculating an amount to be paid in the event of a breach, subcontractors and head
contractors should consider:
The potential daily cost of employees and plant on site;
Daily business operation costs
And many other project-specific risks.

How to ensure liquidated damages clauses are enforceable

The most common way a LDs clause may be contested is where it is argued to be a penalty
and not a genuine estimate of the losses that will be incurred as a result of delays.
A clause will be considered a penalty where the rate specified in the contract is wholly out
of proportion to the interests of the non-defaulting party.[1] Therefore, a lot hinges on the
proposed activities that will result from the project and the degree to which the non-
defaulting party will forego its planned income.
In Grocon Constructions (Qld) Pty Ltd v Juniper Developer No. 2 Pty Ltd & Anor [2015]
[1]
, the Queensland Supreme Court held that in determining whether a rate of LDs
stipulated in a contract constitutes a genuine pre-estimate of the non-defaulting party’s
loss, consideration must be given to the parties’ negotiations in respect of LDs.

In Juniper, the parties had paid particular attention to the LDs clause and Juniper had even
issued a detailed breakdown of the calculations of its potential losses, identifying what it
considered would be its loss if practical completion was not achieved on time.

The Supreme Court also found it highly relevant that the parties were commercially savvy
and had equal bargaining power at the time of negotiating the contract. The amount of
evidence the defaulting party was provided with regarding the estimates and calculations
of potential losses was pivotal in the Supreme Court finding the LDs clause to be a
genuine pre-estimate of loss.

This means the losses that will be suffered by the non-defaulting party, as a result of it
being unable to use the works or the site from the date it could expect to as per the time
frame for completion, must be accurately reflected by the rate specified in the contract. For
example, if the principal intends to use the works or the site for manufacturing or other
business purposes, the rate of LDs should take into account the lost profit and costs
associated with the principal having to delay the commencement of its business
operations.

How are other damages excluded?

The courts have taken and upheld the approach that general damages are typically only to
be excluded where it is expressly stated in the construction contract.

Claiming losses for delay beyond liquidated damages

So what happens if LDs are not listed as the sole remedy for delays?
An interesting situation arises where LDs are not specifically listed as the sole remedy for
delays in a construction contract.

In many instances, contractors have sought to rely on the fact that LDs were stated in their
contract at a rate of “$NIL” or “N/A” as the basis for arguing that general damages were
also excluded from the contract.

However, as the courts have held in cases such as J-Corp v Mladenis [2009] WASCA, if
the parties have agreed to a positive amount for LDs, this will reflect the intention of the
parties to exclude the right to recover general damages. The Western Australian Court of
Appeal held that as no clear and unequivocal words were present in the contract excluding
the owners’ right to claim general damages for delay, but merely wording that provided for
“$NIL” liquidated damages, the owners remained entitled to claim unliquidated damages.
In Adapt Constructions Pty Ltd v Whittaker [2015], the ACT Supreme Court found that a
construction contract based on a standard form which left blank the amount for LDs to be
paid for delays did not prevent the principal from recovering unliquidated damages at
common law. The ACTSC suggested that in determining the parties’ intention to allow a
principal to claim unliquidated damages, the following aspects of the contract must be
considered:

Whether the parties intended for the principal to have that entitlement, having regard to the
language of the contract;
if the contract provides that the principal may elect to claim liquidated damages, this may
indicate that the parties intended that the principal would be entitled to claim both
liquidated and unliquidated damages;
if the contract provides for liquidated damages to be payable automatically, this may
indicate that liquidated damages are intended to be the only remedy; and
an intention to exclude a right to unliquidated damages at common law must be expressed
clearly in the contract.

As is evident from the various courts’ comments on the issue, the prudent course of action
is to include clear and unequivocal words that reflect the parties’ intentions. Do not assume
the party on the other side of the contract has the same expectations as you, as the costs
resulting from delays can add up at an alarming rate.

If you have any questions regarding your liability to pay or entitlement to receive
liquidated damages, please do not hesitate to contact Morrissey Law + Advisory.
This article was prepared by Hamish Geddes.

[1] Paciocco v Australia and New Zealand Banking Group Ltd (2016) 333 ALR 569.
[2] Grocon Constructions (Qld) Pty Ltd v Juniper Developer No. 2 Pty Ltd & Anor [2015]
QSC 102.
https://www.deacons.com/2021/09/23/uk-supreme-court-rules-on-correct-approach-to-interpreting-liquidated-damages-
clauses/

UK Supreme Court rules on correct approach to interpreting liquidated damages

clauses

In Triple Point Technology Inc v PTT Public Company Ltd [2021] UKSC 29, the principal
issue before the Court was the approach to be adopted when interpreting a liquidated
damages clause in a contract i.e. a clause providing for a pre-determined sum agreed upon
in the event of a specified breach by one of the parties. The liquidated damages clause in
this case was in a common form, providing that liquidated damages were payable for each
day of delay by the contractor from the due date for delivery up to the date the employer
accepted such work. The question was whether liquidated damages were payable in
respect of work which had not been completed or accepted before the contract was
terminated. The UK Supreme Court held that they were.

Background
By a Contract, PTT Public Company Ltd (PTT) engaged Triple Point Technology Inc
(Triple Point) to provide a software system. The work was to be carried out in two phases
and payment for the work was to be made by specified milestone dates. Triple Point
achieved completion of stages 1 and 2 of phase 1, 149 days late and PTT paid them for
that work.  Triple Point requested payment of further invoices in respect of work not yet
completed, which PPT refused. Triple Point suspended work and PTT terminated the
contract, maintaining that Triple Point had wrongfully suspended work. Triple Point
commenced proceedings against PTT, claiming sums due under its unpaid invoices. PTT
counterclaimed for liquidated damages for delay prior to termination and for the cost of
having to procure a replacement system from a new contractor.

Relevant contractual terms

The Contract contained the following relevant clauses:
Article 5.3: “If CONTRACTOR fails to deliver work within the time specified and the
delay has not been introduced by PTT, CONTRACTOR shall be liable to pay the penalty at
the rate of 0.1% of undelivered work per day of delay from the due date for delivery up to
the date PTT accepts such work …”
Article 12.1: “CONTRACTOR shall exercise all reasonable skill, care and diligence and
efficiency in the performance of the Services under the Contract…”

Article 12.3: “CONTRACTOR shall be liable to PTT for any damage suffered by PTT as a
consequence of CONTRACTOR’s breach of contract….The total liability of
CONTRACTOR to PTT under the Contract shall be limited to the Contract price received
by the CONTRACTOR with respect to the services or deliverables involved under this
Contract. Except for the specific remedies expressly identified as such in this Contract,
PTT’s exclusive remedy for any claim arising out of this Contract will be for
CONTRACTOR, upon written notice, to use best endeavour to cure the breach at its
expense, or failing that, to return the fees paid to CONTRACTOR for the Services or
Deliverables related to the breach. This limitation of liability shall not apply to
CONTRACTOR’s liability resulting from fraud, negligence, gross negligence or wilful
misconduct of CONTRACTOR or any of its officers, employees or agents.”

Issues before the courts

The issues before the Courts were:
Whether liquidated damages were payable under Article 5.3 in respect of work which had
been delayed by Triple Point and not completed (and therefore not accepted) before the
Contract was terminated.
Whether “negligence” in the exception in Article 12.3 meant the tort of negligence or also
included breach of the contractual duty of skill and care.
Whether liquidated damages were subject to the cap referred to in Article 12.3.

Decisions of the courts below

Technology and Construction Court
The Technology and Construction Court (TCC) dismissed Triple Point’s claim. It held that
PTT was entitled to damages of US$4.5 million, under the heads of: liquidated damages
for delay (uncapped) and the costs of procuring an alternative system and wasted costs
(both subject to the Article 12.3 cap). Triple Point appealed and PTT cross-appealed
against the finding that any damages were capped.

Court of Appeal
The Court of Appeal set aside the TCC’s award of liquidated damages, holding that PTT
was only entitled to liquidated damages for work which had been completed (and therefore
accepted by the employer) prior to termination of the Contract, that all damages were
subject to the cap and that the exception for “negligence” applied only to freestanding torts
and not to breaches of the contractual obligation to exercise care and skill. PTT appealed
to the Supreme Court.

Supreme Court decision

The Supreme Court held that:
PTT was entitled to liquidated damages up to the date the Contract was terminated and
general damages after that – PTT’s appeal was unanimously allowed on this issue.
The limitation of liability in respect of “negligence” provided for in Article 12.3, applied
to both tortious acts and to breach of the contractual duty of skill and care. Therefore,
damages for the breaches were not capped-PTT’s appeal on this issue was allowed by
majority.
The liquidated damages fell within the cap under Article 12.3-PTT’s appeal on this issue
was unanimously dismissed.

The Supreme Court’s reasoning

Liquidated damages are payable in respect of work which had been delayed and not
completed before the contract was terminated  

In concluding that the liquidated damages clause did not apply on termination, the Court
of Appeal had departed from the generally understood position that, subject to the precise
wording of the clause, liquidated damages would accrue until the contract was terminated,
at which point the contractor becomes liable to pay damages for breach of contract. The
Court of Appeal had held that in some cases, it might be inconsistent with the parties’
agreement to categorise the employer’s losses as subject to the liquidated damages clause
until contractual termination and thereafter as damages.

However, the Supreme Court held that the Court of Appeal’s approach was inconsistent
with commercial reality and the accepted function of liquidated damages, namely to
provide a remedy that is predictable and certain for a particular event, the event often
being delay in completion, as in this case. The employer does not then want to have to
quantify its loss, which may be difficult and time-consuming for it to do. Termination of
the contract should not eliminate rights that the employer has already accrued, without
express provision for such in the contract.

The Supreme Court said that the parties must be taken to know the general law, namely
that the accrual of liquidated damages comes to an end on termination of the contract and
after that event, the parties’ contract is at an end and the parties must seek damages for
breach of contract under the general law. It went on to say that this is well-understood and
parties do not have to provide specifically for the effect of the termination of their
contract. The Supreme Court disagreed with the Court of Appeal’s ruling that “If a
construction contract is abandoned or terminated, the employer is in new territory for
which the liquidated damages clause may not have made provision.” The territory is well-
trodden, the Supreme Court said, and the liquidated damages clause does not need to
provide for it.
“Negligence” in Article 12.3 meant both the tort of negligence and breach of the
contractual duty of skill and care.

The majority of the Supreme Court held that the Court of Appeal had been wrong to treat
damages for breach of the contractual duty of skill and care as subject to the cap in Article
12.3. It said that “negligence” has an accepted meaning in English law (which was the
governing law of the Contract) and covers both the separate tort of failing to use due care
and also breach of a contractual provision to exercise skill and care. The Supreme Court
said that matters referred to in the final sentence of Article 12.3 were all characteristics of
conduct: fraud, wilful misconduct, gross negligence and negligence and these could apply
to breaches of the Contract. Considering the sentence as a whole, it was clear that it
included an act which was a breach of contract and which possessed one of those
characteristics. Accordingly, the cap carve-out should be given its natural and ordinary
meaning of removing from the cap all damages for negligence on Triple Point’s part,
including damages for negligent breach of contract.

Liquidated damages were subject to the cap in Article 12.3

The Supreme Court held that the Court of Appeal was right to hold that (subject to the
carve-out for negligence) liquidated damages fell within the cap and counted towards the
maximum damages recoverable under the cap.

The Supreme Court said that the way in which the contract worked was that (i) Article 5.3
provided a formula for quantifying damages for delay; (ii) sentence 3 of Article 12.3 dealt
with breaches of contract not involving delay and therefore necessarily included the words
“Except for the specific remedies expressly identified as such in this contract”. That phrase
referred to liquidated damages under Article 5.3. Sentence 3 of Article 12.3 imposed a cap
on the recoverable damages for each individual breach of contract; (iii) Sentence 2 of
Article 12.3 imposed an overall cap on the contractor’s total liability, meaning that it
encompassed damages for defects, damages for delay and damages for any other breaches.
https://chamberlains.com.au/delay-costs-delay-damages-the-prevention-principle/
14.12.21
By Chamberlains Admin

Delay Costs, Delay Damages & The Prevention Principle

General Principles
Delay costs vs delay damages
Contractors are often faced with various obstacles delaying the critical path of a
construction programme. Often, those obstacles and delays are the result of actions of the
principal, their employees or agents.

One of the most discussed issues in construction litigation is how a contractor may seek
costs and damages arising from the delay caused by the principal and avoid the imposition
of liquidated damages for failing to adhere to the construction programme and practical
completion.

A principal to a construction contract is obliged to allow full and unrestricted access to the
site and is required to make available as much as is required for the works to be performed
under the relevant construction contract. A failure to do so may amount to a substantial
breach: Carr v J A Berriman Pty Ltd (1953).  

At common law, there is no automatic right to delay damages, as damages can only be
recovered if they can be proven to be damages arising from a breach of contract. The
automatic provision of delay damages can only occur if the contract specifically provides
(most commonly liquidated).

Accordingly, there must be a sufficient nexus between the loss actually suffered and the
event giving rise to the delay, as the loss must flow from the breach.

This is distinguished from delay costs, whereby a contract will provide for the recovery of
costs expended in the absence of a breach but where delay has been experienced.
Typically, construction contracts will provide entitlement to further time in the event of a
delay, and further, an express right to the costs and expenses arising by reason of the delay.

In the absence of an express entitlement, the aggrieved party would need to rely on
compensation via the general law in the form of a cause of action for breach of contract
(i.e. the failure to provide sufficient access to the site).
Where delay costs are available, they will typically be in the form of:
(a) Agreed (or liquidated damages); and/or
(b) In the form of reimbursement for costs incurred.
Where liquidated damages apply, the need to quantify the damages via a breach of contract
at general law is removed.

In circumstances where liquidated damages arise from delay, those damages need to be a
genuine pre-estimate of the damage resulting from the delay and owing to the initial
breach. The nexus between act/omission and loss is essential. If they are not, the provision
may be set aside as a penalty.

Where a construction contract does not provide an express entitlement to further time in
the event of delay caused by the principal, time will be “set at large”.

Time “at large” and the prevention principle

Under the general law, a principal to a construction contract cannot hold the contractor to a
specified completion date if the principal has prevented the contractor from completing by
that date by act or omission.

Instead, time becomes at large, and the obligation to complete the project by the specified
date is replaced by an implied obligation to complete within a reasonable time. The same
principle applies between the main contractor and sub-contractors.

Generally, the prevention principle operates to prevent liquidated damages clauses from
being enforceable by the party responsible for a breach or an act/omission causing a delay.
In order to avoid the operation of the prevention principle, most construction contracts and
sub-contracts include provisions for an extension of time.

There is a strong argument that extension of time clauses exist for the protection of both
parties to a construction contract or subcontract and that if a contract provides for an
extension of time owing to acts of prevention by the principal, then the principle will not
apply: Multiplex v Honeywell (2007) BLR 195 TCC.

In Turner v Co-ordinated Industries (1994) 11 BCL 202 (Turner), the Court considered

circumstances where under the contract, the contractor was entitled to an extension of time
if the principal breached the contract.

The Court said that the prevention principle did not apply and listed three considerations to
make before the prevention principle will apply:
(a) If the contract includes any provision that entitles the contractor to an EOT when the
principal breaches the contract, then time cannot be set at large by the principal’s breach of
contract;
(b) In the absence of such a clause, the principal’s actions must cause “actual” delay for
the Prevention Principle to apply; and
(c) One must determine what the overall effect of the action of the principal was. A small
actual delay by the principal does not allow other delays by the contractor to be eradicated
from consideration on the basis of the prevention principle.

Prolongation and compensable delays

In addition to an extension of time, a contractor may be entitled to the associated costs and
expenses arising by reason of delay or prolongation. Where a contract does not provide
such express entitlement, the contractor would need to prove its entitlement via a general
law cause of action (breach of contract) or an act of prevention by the other party.

The default entitlement of the contractor to prolongation under most standard forms is
causes for which the other party is liable. This is defined as a “compensable delay.”
Therefore, a prolongation claim is one where a party to a contract is entitled to additional
costs which arise as a result of a “compensable delay”.

Compensable delays affect the critical path and give rise to an entitlement to EOT,
subsequently leading to the entitlement to recovery of prolongation costs. 

Examples are variation or change order or site instruction requiring additional costs, which
would not have arisen if those instructions were not issued by the head contractor.

This is separate from a claim for disruption where certain events occur causing a delay but
do not trigger an EOT. It is also distinct from an “excusable delay” such as a Force
Majeure event such as inclement weather.

In essence, the prolongation claim must be compensable, affect the critical path and delay
the completion of works.

Apportionment for concurrent delay

Australian Courts have moved to temper the “prevention principle” in circumstances
where there is a concurrent contribution to delay by two parties to the contract
(see Trollope & Colls Ltd v North West Metropolitan Hospital Board [1973] 1 WLR 601).

The courts are now prepared to contemplate that a party to a contract that has been
prevented from fulfilling its contractual obligations by the conduct of another party cannot
rely upon the failure by that other party if it could not have complied with its contractual
obligation in any event (Turner).

In Turner, it was decided that the “prevention principle” should apply in circumstances in
which the principal (or party causing the prevention) has caused the actual delay and that it
was not sufficient that the principal caused the delay to the completion of the work.
The principal’s delay must be judged in “all circumstances of the case” and may allow
some relief to the contractor.
https://www.ashurst.com/en/news-and-insights/legal-updates/quickguides-liquidated-damages/

Liquidated Damages
This guide explains the critical steps to take in making sure liquidated damages clauses
are enforceable.

Liquidated damages clause

Including a liquidated damages (LD) clause in a commercial contract is a popular way of
dealing with the possibility of breach. The essence of an LD clause is that a party in breach
of its obligations under a contract is obliged, by that contract, to pay a particular sum by
way of compensation for that breach. The sum is fixed in advance and written into the
contract.

The courts recognise the advantages of these clauses for both parties. These, combined
with the general principle of freedom of contract, have led to a general view on the courts'
part that these clauses should be upheld, especially in a commercial context where the
parties are seen as free to apportion the risks between them. However, an LD clause which
constitutes a penalty will not be enforceable. A number of pointers have emerged from the
case law on the topic which must be taken into account when considering this issue. There
are also a number of drafting points to follow which will help any such clause to be
upheld.

LD clauses: a practical remedy with numerous advantages

LD clauses have much to recommend them in the commercial context. The most important
element of such a clause is that the sum specified is payable once the breach occurs
without the need to wait for the loss to crystallise. The injured party is spared the time and
expense of a common law action for damages for breach of contract. Neither is it under
any obligation to mitigate as it would be in an ordinary claim.

Remoteness of damage can also be an issue in a contractual damages claim. However,

where the non-breaching party can rely on an LD clause, questions of remoteness do not
arise. This in turn means that potential problems of under-compensation for the injured
party may well be avoided, especially in situations where significant consequential or
idiosyncratic losses result from the breach. Further, knowing in advance their potential
exposure on a breach brings an extra degree of certainty to the parties and also, perhaps, to
their insurers. Sensible LD provisions (for example the service credit regime built into
many outsourcing contracts) can be a practical and workable method of dealing with
minor breaches throughout a long-term contract; one advantage of this is that the parties
often find it possible to continue their commercial relationship going forward despite an
element of past poor performance.
Identifying a genuine LD clause
As mentioned above, the essence of a liquidated damages clause is that the sum which the
breaching party must pay on a breach is fixed in advance and written into the contract.

Distinguish the following:

Indemnities: Commercial contracts often provide for the breaching party to indemnify the
non-breaching party in respect of any loss it suffers as a result of the breach. However,
unlike a true liquidated damages clause, the sum payable is not known until the breach has
occurred and the loss has crystallised.

Clauses where the sum payable in respect of the breach is fixed by a third party: Again,
these are not true LD clauses because the sum is determined by an external factor, and
after the breach, rather than being specified in the contract.

Incentive payments: Some contracts provide for the contract sum to increase if the supplier
meets certain milestones ahead of time. Although this is often a very effective way of
securing performance, the payment increase is not triggered by breach and such a clause
therefore operates in the opposite way to a genuine LD clause.

Typical uses of LD clauses

Situations in which LDs often appear include:
Construction contracts: These typically provide that, if completion is delayed by reason
of the contractor's breach, the contractor will be liable to pay the employer a specified sum
for each day, week or month during which the delay continues.
IT development contracts: The mechanism works in a similar way to that described
above with payments triggered by delays in completion.

Outsourcing contracts: In this context, LDs often take the form of service credits which
apply to reduce the sums payable if services are not performed to the required standard.
Employment contracts: Two examples of LD clauses in employment contracts have
come before the courts in recent years1. In one, it is worth noting that the judge
commented that, although it was unusual to find them in this type of contract, there is no
reason why they should not be used. 

The penalty trap and the risk of unenforceability

The considerable advantages of LD clauses will be lost if the clause is not legally
enforceable. The courts recognise that the benefits of LD clauses, supported by the
underlying theory of freedom of contract, strongly point to such clauses being upheld. This
is particularly so in a commercial context. However, they are not foolproof. Ultimately, a
clause which operates this way can be either an LD clause, in which case it will be
enforceable, or a penalty, in which case, as a matter of public policy, it will not. The courts
have examined the penalty issue on many occasions in the context of LD clauses and it
came under the spotlight of the Supreme Court in 2015 in the case of Cavendish Square
Holdings BV -v- Talal El Makdessi. Here, it was acknowledged that although the doctrine
of penalties is an "ancient, haphazardly constructed edifice which has not weathered well",
it still plays a useful role in regulating commercial contracts. The key steps are knowing
when the rule applies and, secondly, what constitutes a "penalty".2

When does the penalty rule apply?

The purpose of the rule is to prevent a claimant in a breach of contract situation from
claiming any sum of money or other remedy which bears little or no relation to the loss
actually suffered. It examines the fairness of the remedy and not the fairness of the deal as
a whole. In other words, it applies to the secondary obligations in a contract (i.e., those
which come into play when the primary obligations are breached) and not the primary
obligations themselves. See paragraph 7 below for examples.

What makes a contractual provision penal?

The courts have traditionally applied four tests3 to decide this question. These are:
A provision will be penal if the sum provided for is "extravagant and unconscionable" in
comparison to the greatest loss that could conceivably be shown to result from the breach.
A provision will be penal if the breach consists solely of the non-payment of money and it
stipulates a larger sum.

A clause will be presumed to be penal if the same sum is payable for a number of breaches
of varying degrees of seriousness.

A clause will not be treated as penal solely because it is impossible to estimate in advance
the true loss likely to be suffered.

In the Supreme Court's view, these four tests have, over time, been given more weight than
was originally intended, which has led to artificial distinctions creeping in to the penalty
doctrine. The recent shift towards looking at the "commercial justification" of clauses was
an attempt to steer judicial thinking back to the fundamental principles behind the penalty
rule but was misguided. Focusing on the true purpose of the clause - i.e., to deter a breach
or to compensate for loss - is not helpful either. While these four tests remain helpful
guidance, the true test is whether the remedy is disproportionate to the legitimate interest it
was designed to protect.

The reformulated test. In practice, this will involve a value judgement by the court and
the first step in this process is identifying the legitimate interest which the clause in
question is designed to protect. The next step is to look at the remedy. If that clause is a
secondary obligation which imposes a detriment on the breaching party which is out of all
proportion to the non-breaching party's interest in enforcing the primary obligation, then it
will be unenforceable as a penalty. This is likely to be reasonably straightforward for
simple liquidated damages clauses. For other, more complex situations, the principle
remains the same - the court should ask whether the remedy is "exorbitant or
unconscionable".

LD clauses in a subcontracting situation; unenforceable LDs cannot act as cap

The decision in Steria Ltd -v- Sigma Wireless Communications Ltd4 is a useful illustration
of how LDs work in practice in a subcontracting situation. The background involved a
contract for the provision of a new computerised system for fire and ambulance services.
Sigma, the main contractor, sub-contracted part of the work to Steria on terms which
provided for Steria to complete its tasks in four main sections with LDs payable if a delay
occurred in any of those sections. Under the sub-contract, 0.25 per cent of the value of
each task was deductible for each week during which completion of that task was delayed.
The total LD sum was capped at 10 per cent of the contract price. The main contract had a
similar cap on the total but LDs were fixed at 1 per cent of the contract value for each full
or partial week that overall completion was delayed. Delays occurred; Sigma claimed LDs
and, in the alternative, general damages from Steria.

One of Steria's arguments centred on whether the LDs were penal in nature. Steria argued
that the structure of the contract, with LDs payable in respect of each section, could
operate as a penalty if the final completion date was ultimately met irrespective of delays
having occurred in completing any one of the first three tasks. Because achieving
completion of the sub-contract on time did not translate into a delay under the main
contract, Sigma would not be liable to its customer, although Steria would be liable for
LDs under the sub-contract. The judge did not accept this. Delays in tasks 1-3 may well
have caused Sigma loss even if the final completion date could be met. Sigma, or other
sub-contractors, could conceivably suffer delays and disruption, thus incurring losses or
expenses which could not be recovered elsewhere. It was also relevant that both contracts
capped the total recoverable LDs at 10 per cent. The clause was not penal. Neither did the
judge think that a general damages claim was a possibility, because the contract clearly
stated that Sigma's sole remedy was LDs. He did, however, offer the view that if the LD
clause had been unenforceable as a penalty it could not in any way act as a cap.

Limiting the scope of the penalty rule: sum in question must be payable as a result of
breach
The rule against penalties is not applicable to many payments made under a contract.
Three cases provide some guidance on the point. One very helpful test is whether the sum
is payable as a primary obligation or whether it is payable as a secondary obligation, i.e.,
on breach of a primary obligation. If the former, it will not be a penalty. This suggests that,
wherever possible, the relevant clause should be drafted as a primary obligation rather than
as a remedy for a breach. The point arose in Makdessi in relation to two clauses, the first
of which withheld the payment of two final instalments of the purchase price, and the
second of which provided for the transfer of shares at a reduced price, if various restrictive
covenants were breached. The Supreme Court, after some debate (and in the case of the
transfer of shares not unanimously), held that these clauses constituted primary obligations
as they amounted to a price adjustment mechanism closely tied in to the overall
commercial objective of the deal. In Associated British Ports -v- Ferryways NV5 the
parties entered into an agreement for handling cargo containers at a port. The agreement
contained a minimum throughput obligation which provided that, if the number of Units
(as defined) fell below a certain number in each year, the customer would nevertheless be
obliged to pay a fixed fee. The customer subsequently argued that this was a penalty. The
judge, however, noted that, on the correct construction, the aim of the clause was to
provide the supplier with an annual revenue stream and not to threaten the customer into
performing. The obligation was not a secondary one, triggered by a breach, but was
instead a primary obligation given in exchange for a promise by the supplier "…and as
such cannot be a penalty".

A similar issue was raised in M&J Polymers Limited -v- Imerys Minerals Limited. This
involved a "take or pay" clause in an agreement for the supply of dispersants. The buyer
was obliged to pay for minimum quantities of the materials even if it had not ordered
them. One of several points which the court had to decide was whether this clause
constituted a penalty. Counsel could find no direct authority on this, so the judge was
obliged to decide it de novo. He commented that the clause was "not the ordinary
candidate for such rule", but the law on penalties could potentially apply.
Following Makdessi however, the general view is that take or pay clauses are likely to be
analysed as primary obligations, therefore falling outside the scope of the rule on
penalties.

The need for a link between breach and remedy was highlighted in Edgeworth Capital
(Luxembourg) Sarl -v- Ramblas Investments BV.6 Here the court held that payment of a fee
which was merely accelerated in the event of a default, but which would have been
payable anyway, was not subject to the penalty rule.

Commercial background and type of contract is significant

As always, when applying the penalty rule, the court will look at the substance of the
clause in question rather than its form or how it is labelled by the parties. The overall
fairness of the deal will not be relevant. However, in Makdessi, the Supreme Court pointed
out that context can sometimes be relevant and, in particular, in a "negotiated contract
between properly advised parties of comparable bargaining power, the strong initial
presumption must be that the parties themselves are the best judges of what is legitimate in
a provision dealing with the consequences of breach".

Comment: These decisions show the flexibility of LD clauses as a potential remedy in

many commercial contexts. Although the rule against penalties remains the biggest risk to
the enforceability of these clauses, lawyers can be reassured by the courts' continuing
reluctance to intervene in contractual relationships between experienced commercial
parties unless absolutely necessary. The focus on "legitimate interest" is worth bearing in
mind, however, and it may be sensible to identify this in the contract itself. In fact,
in Makdessi, the contract expressly recognised that the restrictive covenants in question
had been included specifically to protect the extremely valuable goodwill in the business
being sold. It is also worth noting the courts' increasing awareness of the commercial
background and justification underlying LD clauses and the context in which they were
agreed and it may be sensible for parties to keep written notes of the background and
reasons for choosing the sums they did.

Tullett Prebon Group Ltd -v- El-Hajjali [2008] EWHC 1924 (QB); [2008], IRLR 760 and Murray -v-
Leisureplay Ltd [2005] EWCA Civ 963; [2005] IRLR 946.
[2015] UKSC 67.
Originally formulated in Dunlop Pneumatic Tyre Co Ltd -v- New Garage and Motor Co Ltd [1915] AC
79.
[2007] EWHC 3454 (TCC).
2 Lloyd's LR 2008 355.
[2015] EWHC 150 (Comm).
https://www.alambassociates.com/liquidated-damages-as-an-exhaustive-remedy/

Liquidated Damages as an Exhaustive Remedy?

In this article Senior Quantity Surveyor Danny Beever examines the purpose of Liquidated

Damages in construction contracts and the extent to which they act as an exclusive remedy
for a breach.

Why have a Liquidated Damages Provision?

Liquidated Damages are a predetermined amount agreed in the negotiation of a contract
that are to be paid in the event of a specific breach. Usually in construction, they are used
to indemnify the employing party for a delay to completion and are set at a fixed rate or as
a percentage of the contract value, per week or per day, for the period of delay[1].
Inclusion of a Liquidated Damages provision can mutually benefit the contracting parties
for several reasons. Having a set figure for delay damages gives commercial certainty to
both employer and contractor by having clear risk of financial exposure in place. Another
key advantage is that Liquidated Damages eliminates the often considerable time and
expense involved in agreeing general damages. Avoiding such disputes, by having a
pragmatic and simple way of claiming damages, can also limit the negative impact on the
parties’ future commercial relationship.

Other advantages of the provision include providing a limitation to contractor’s financial

liability if they delay completion. Liquidated Damages can also provide a benefit by
incentivising a contractor to perform and complete on time.

An Exhaustive Remedy?
There is some debate as to extent to which Liquidated Damages represent an exhaustive
remedy for a breach. Seemingly not to make them the sole solution invalidities their
purpose of providing commercial certainty if the employer is able to elect to claim general
damages in addition, or as an alternative, to Liquidated Damages[2].

The courts have been consistent in upholding Liquidated Damages as being an exhaustive
remedy.

In Temloc v Errill Properties Ltd [3], the employer had inserted ‘£nil’ as the rate for
liquidated damages within the contract. The court held that this meant that the parties had
agreed that there should be no damages for delayed completion. This agreement was to be
exhaustive, and the employer was not able to claim general damages for the breach.

In Pigott Foundations Ltd v Shepherd Construction Ltd [4], the main contractor looked to
claim additional general damages due to delays caused by Pigott arguing that the
Liquidated Damages provision in the subcontract was only a limitation of Pigott’s liability
for Liquidated Damages passed down from the main contract. In this case, the judge said:
‘The effect of a provision for the payment of liquidated damages for delay in a building
contract has been considered in a number of recent authorities from which it is clear that
not only does such a clause have the effect of imposing a liability upon the party who is
responsible for the delay to pay damages at the stated rate but also it has the effect of
precluding the other party to the contract from seeking to avoid the limitation on any
amount of damages contained in a liquidated damages clause…’

Like Temloc, this case the upholds that the employer cannot avoid the limitation of liability
that Liquidated Damages puts in place. A similar ruling was also made in Surrey Heath
Borough Council v Lovell Construction Ltd [5] where it was found that an employer could
not elect whether they applied Liquidated Damages or claim general damages.

‘Simple Delay’, Mitigation Costs and Termination

The courts have also considered whether Liquidated Damages extend beyond the simple
breach of not completing on time or if breaches of other obligations which cause delay
gave rise to additional claims. In Biffa Waste Services Ltd v Maschinenfabrik Ernst Hese
GmbH [6] the judge failed to see a distinction between simple delay and other breaches
causing delay.
‘…I do not consider that it is possible to draw a distinction between a “simple” failure to
complete and a failure to complete caused by breach of another obligation. If there is a
failure to complete, then liquidated damages are “the only monies” due for such default. If
there is a breach of another obligation and that breach causes a failure to complete then
liquidated damages are still the only monies due for that default, that is a breach of
contract causing a failure to complete on time.’

The judge, in a clear validation of the commercial purpose of Liquidated Damages being a
sole remedy, also said:
‘I do not accept that a liquidated damages clause which only applied to a case where there
was simply a failure to complete on time without a breach of any other provision would
make commercial sense.’
This case also reviewed claims by the employer for additional damages to cover mitigation
costs in their attempt to alleviate the delay. Whilst these are usually recoverable as
general damages, the court ruled that mitigation costs are to be considered included in the
rate of Liquidated Damages.

The recent case of Triple Point Technology, Inc v PTT Public Company Ltd [7]also gives
certainty on Liquidated Damages following termination of the contract. The Supreme
Court’s decision was that Liquidated Damages should apply up to the date of termination.
This means that Liquidated Damages are likely to be an exhaustive remedy for delay in the
event of termination although the employer may be able to claim general damages after
date of termination.
A Limit on General Damages?
There is still some uncertainty as to whether Liquidated Damages are exhaustive in the
sense that they limit the value of a successful claim for general damages. If a Liquidated
Damages clause becomes inoperative, for example if it is found to be a penalty as per the
test in Cavendish Square Holding BV v Makdessi [8] or if time is at large, then the
employer may have a claim for general damages. In making a claim, the employer may be
able to show that their actual damages exceed the sum of Liquidated Damages. Whilst
there is no clear rule from the courts that Liquidated Damages limit a claim for general
damages[9], it is unclear whether a such a claim would be successful. If it were, then this
would give rise to a situation where an employer could intentionally make a Liquidated
Damages inoperative in order to claim a greater sum in general damages [10].

Conclusions
The courts hold a consistent approach that Liquated Damages represent an exhaustive
remedy for delay for an operative clause and that they are keen to protect the commercial
motives of the provision.

Employers should note the extent to which they are deemed exhaustive when negotiating
contracts. Other breaches by the contractor that cause delay, such as defective works, and
their own costs to mitigate the delay all need to be considered.

An article written by Danny Beever

 
[1] Keating on Construction Contracts (11th Edition) 10-001
[2] Brian Eggleston, Liquidated Damages and Extensions of Time: In Construction
Contracts (Third Edition, Wiley-Blackwell 2009) page 6.
[3] (1987) 39 BLR 30 (CA).
[4] (1993) 67 BLR 48.
[5] (1988) 42 BCR 25.
[6] [2008] EWHC 6 (TCC);(2008) 118 Con. L.R. 104.
[7] [2021] USKC 29
[8] [2015] UKSC 67
[9] Brian Eggleston, Liquidated Damages and Extensions of Time: In Construction
Contracts (Third Edition, Wiley-Blackwell 2009) page 57-58.
[10] Will Hughes et al, Construction Contracts: Law and Management (Fifth Edition,
Routledge 2015) page 340.