Olswang Construction Law Masterclass - October 2014 - Liqudated Damages and Penalties
1. Liquidated damages and penalties
7 October 2014
Ben Worthington, Senior Associate
ben.worthington@olswang.com | + 44 20 7067 3541
2. What are liquidated damages?
â˘Definition of liquidated damages
â˘A pre-determined sum payable by the defaulting party in the event of a
specified breach of contract
â˘Genuine pre-estimate of loss
â˘Liquidated v unliquidated damages
â˘Liquidated damages for non-delay related losses: Bluewater Energy Services BV
v Mercon Steel Structures BV and others [2014] EWHC 2132 (TCC)
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3. Why use liquidated damages?
â˘Complexity of claims in construction disputes
â˘Saves time and cost
â˘Avoids dispute procedures
â˘Avoids need to establish loss
â˘Certainty
â˘Cost of delay is clear âincentivises
â˘Risk of delay easier to price
â˘Limits liability
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4. Are liquidated damages an
exhaustive remedy?
â˘a liquidated damages clause normally covers all damages for non-completion
â˘Temloc Ltd v Errill Properties Ltd (1987) 39 BLR 30
â˘rate of LDs stated as "ÂŁnilâ
â˘Court of Appeal held that parties had agreed that no damages would be
payable for the breach in question.
â˘Biffa Waste Services Ltd and another v Maschinenfabrik Ernst Hese GmbH and
another [2008] EWHC 6 (TCC)
â˘Biffa argued LDs was an exhaustive remedy only for delay not caused by a
breach of any obligation
â˘claimed unliquidated damages for breach of obligations of reasonable skill
and care which had caused a fire and, as a consequence, delay
â˘Held: no distinction between a âsimpleâ failure to complete and a failure to
complete caused by another breach âLDs were âthe only moniesâ due for
such default.
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5. Defences to claim for liquidated
damages
A party may challenge the imposition of liquidated damages on the basis that:
â˘The liquidated sum is penal in nature
â˘The right to deduct LDs has not crystallised because:
â˘The breach is not within the scope of the clause
â˘A condition precedent for deducting LDs has not been complied with; or
â˘The clause fails for uncertainty: Bruno Zornow (Builders) Ltd v Beechcroft
Developments Ltd [1990] 51 BLR 16
â˘Sectional completion and partial possession
â˘No date in contract
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6. Penalty clauses - introduction
â˘The court will not enforce penalty clauses
â˘BUT: difficult to establish that a clause is a
penalty
â˘the courts are pre-disposed to uphold
liquidated damages clauses:
â˘court reluctant to interfere in a
commercial bargain
â˘contractor must establish penalty â
high bar
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7. Penalty clauses â general
principles
â˘Dunlop Pneumatic Tyre Co Ltd v New Garage Motor Co Ltd [1915] AC 79
â˘The use of the phrase âliquidated damagesâ in a contract is not conclusive
â˘Was the predominant function of the clause to deter a party from breaching
the contract (a penalty) or to compensate the innocent party for breach
(enforceable)
â˘The essence of a liquidated sum is that it is a genuine pre-estimate of loss,
judged at the date of the contract, not as at the time of breach
â˘But see: Unaoil Ltd v Leighton Offshore Pte Ltd [2014] in respect of
variations to contracts - where "...the contract is amended in a relevant
respect, the relevant date is⌠the date of such amended contract."
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8. Recognising a penalty clause (1)
â˘Is the purpose of the clause to intimidate or penalise, or is to
compensate?
â˘Alfred McAlpine Capital Projects Ltd v Tilebox Ltd [2005] EWHC 281
(TCC)
â˘Is the liquidated sum reasonable?
â˘Is the liquidated sum extravagant or unconscionable by comparison
with the greatest loss that might be suffered?
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9. Recognising a penalty clause (2)
â˘Employer does not have to accurately predict its likely loss
â˘Philips Hong Kong Ltd v Attorney-General of Hong Kong
â˘âit will not normally be enough to identify situations where the
application of the provision could result in a larger sum being
recovered by the [Employer] than his actual costâ
â˘Court will investigate the background to the contract at the date the
contract was entered - what is a reasonably foreseeable loss?
â˘If the Employer can show that he arrived at the sum with calculations /
projections (e.g. loss of income, increased financing costs) then strong
evidence of genuine pre-estimate
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10. The challenge succeedsâŚ
â˘Unaoil Ltd v Leighton Offshore Pte Ltd
â˘Agreement in relation to an oil pipeline âprice $75M
â˘LDs payable to sub-contractor if contractor breached agreement -
$40m (stipulated as a âgenuine pre-estimate of lossâ)
â˘Contract price later varied âminimum price $55M
â˘The liquidated sum of $40 million was "manifestly one which could no
longer be a genuine pre-estimate" given that the amendment reduced
the total price.
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11. The challenge failsâŚ
â˘Alfred McAlpine v Tilebox
â˘LDs = ÂŁ45,000 per week
â˘2 year delay (LDs circa ÂŁ5.5m)
⢠£45,000 - âat or slightly above the top of the range of possible weekly
losses flowing from the delayâ
â˘the gap between it and an appropriate yardstick âwas not nearly wide
enough to warrant characterising this clause as a penaltyâ
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12. The commercial justification test
Azimut-Benetti SpA v Healey
â˘Shipbuilding contract:
â˘buyer to pay shipbuilder $38M over 3 years
â˘In the event of a late payment, the builder could end the contract and retain (or
recover) 20% of the contract price by way of LDs âany remainder would be repaid
â˘A common alternative to this was for the builder to retain all installments paid,
build the yacht and then sell it - this could take a very long time for builder to
realise its loss
â˘the purpose of the clause was not to deter breach of contract, it was
commercially justifiable as providing a balance between the parties
â˘Both parties had the benefit of expert advice and terms were freely entered
into
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13. The commercial justification test(2)
â˘Court of Appeal in Cavendish Square Holdings BV and another v El
Makdessi [2012] EWHC 3582
â˘Rejected approach of rigid dichotomy between a genuine pre-estimate of loss,
on the one hand, and a penalty on the other
â˘There are provisions which, while they do not reflect a genuine pre-estimate
of loss, nevertheless have a commercial justification which means that their
predominant purpose is not to deter breach
â˘starting point is to consider whether the relevant provision is extravagant and
unreasonable
â˘Even if the sum is extravagant and unreasonable, not necessarily penal; a
commercial justification for the provision may lead to conclusion that deterrent
was not the dominant purpose of the term
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14. What if a challenge succeeds?
â˘party can claim general damages
â˘BUT the failed liquidated damages clause may act as a cap on the general
damages
â˘limited case law on this point
â˘unlikely that an Employer can impose excessive liquidated damages and then
avoid its effect to recover more
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15. Practical tips
â˘Be clear as to what event triggers the right to deduct damages
â˘Ensure that there is an adequate procedure for extending time
â˘Ensure LDs clause provides for sectional completion or partial possession i.e.
â˘It gives specific rates of LDs for specific sections
â˘reduces the rate of LDs if the employer takes partial possession
â˘Properly record any forecasts /estimates of loss / negotiations relating to the
liquidated sum
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