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Liquidated damages clauses – gain or pain?

24 Jun 2013

What are Liquidated Damages?

Most forms of Building Contract include a “Liquidated and Ascertained Damages” clause (“LADs”), entitling the Employer to an agreed level of damages if the Contractor doesn’t complete the project on time. LADs replace the Employer’s common law right to claim damages, for the losses caused by a delay in completion, with the agreed pre-determined figure specified in the Contract.

The fact that the Employer’s loss can ultimately be shown to be of a greater or lesser sum than the agreed figure is irrelevant. It is the LADs figure which can be claimed as damages for the delay. LAD provisions are usually stated to be a particular sum payable for each day, week, or part of a week, by which the date of completion of the project is delayed. Other possibilities are a specified lump sum, a fixed percentage of the Contract Sum or a maximum rate which gradually reduces as part of the project becomes available for occupation and use.

Genuine pre-estimate of the loss

The Employer must be able to demonstrate that the figure they have included in the Contract for LADs is a genuine pre-estimate of the loss they are likely to suffer in light of the prevailing circumstances at the time the Contract was made. If the Employer is unable to show that the figure is a genuine pre-estimate of the loss, then the clause will be regarded as a “penalty” and the courts will not enforce it. A prudent Employer should therefore retain calculations demonstrating how the LADs figure has been derived to defeat any allegation of a penalty made by the Contractor.

Beware – the figure is binding

Where the parties have agreed a figure for LADs which is not regarded as a penalty, the court will be reluctant to interfere with that agreement. The case of Temloc Limited .v. Errill Properties Limited (1987) stands as a precautionary example to Employers regarding the LAD figure inserted in the Contract. In that case, the LADs figure inserted was “£nil” and the court declared that this was clearly the figure agreed between the parties and they would not interfere with that agreement. The case would have been different if no figure at all had been included, as this would demonstrate that the parties did not intend to include LADs in their contract.

If a court should decide that a LADs clause is unenforceable, this does not prevent the Employer from making a claim at common law alleging a breach of contract by the Contractor, namely failing to complete the works by the agreed contractual completion date. It should also be remembered that the LADs figure is intended to compensate the Employer for the delay that has occurred to the Contract. The Employer still retains a right to bring a claim for damages for any other breaches of contract that have occurred which can be separated from the delay breaches.

Tread with caution

The inclusion of a LADs clause in the Contract provides both the Employer and Contractor with a degree of financial certainty. However, should a delay to the completion of the contract occur, both parties should pay due respect to the size of the proposed LADs figure. The court is unlikely to hear the cry of a party that the sum in no way properly reflects the loss that the delay has actually caused if there is a clear acceptance of the figure at the time the contract was made.

For further information or advice, please contact Graham Sutton on 0191 232 8345 or email graham.sutton@hay-kilner.co.uk.

Please note:
This article is not legal advice; it is intended to provide information of general interest about current legal issues. Please contact us to discuss how the contents of the article may affect you.