We're often asked to advise on what is the appropriate level of liquidated damages for delay in a building contract. Whilst this is a commercial issue and therefore outside the remit of legal advice there are some principles relating to the application of liquidated damages that we can bring to the parties' attention.
Liquidated damages for delay are an agreed fixed amount, usually either a daily or weekly amount, which are payable by the contractor (or consultant) if the works/services are not completed by the contractual completion date. In contrast to "general damages" it is not necessary to prove that any loss has actually been suffered by the employer. There may also be liquidated damages agreed for other breaches of contract (such as failure to achieve target areas and in recent years with the increased focus on sustainability it may be that failure to achieve certain sustainability criteria may also attract a LD (particularly as proving a directly occurring loss may not be straightforward).
What are the benefits of including LDs?
By including LDs in a contract, the parties benefit in several ways:
1. Certainty: the contractor knows the exact amount of its liability for the specified breach and can also better price for the risk, whereas the employer has a readily available remedy for the breach and need not prove its loss.
2. Limiting the liability: LDs generally cap the contractor's liability for the specified breach - the benefit that both parties are fully aware of how much the contractor is liable for under the contract. It is, therefore, important that both the employer and contractor fully consider the risk of the breach and the likely impact if it takes place so that neither party finds itself in an unconscionable position.
3. Deterrence: the agreed sum of LDs is meant to act as a deterrence against breach of contract.
What is the test for LDs?
Historically, the rate of liquidated damages was required to be a genuine pre-estimate of loss (known as the Dunlop Test). In our experience, many parties are still under the mistaken belief that this remains the test (if we had a £ for every time this is mentioned when discussing LDs….). However, in Cavendish Square Holding BV -v- Talal El Makdessi [2015] UKSC 67, the Supreme Court recast the test with the court suggesting a lighter touch approach should be taken.
Following this decision the test is no longer whether LDs reflect a genuine pre-estimate of loss, but rather whether the particular provision/penalty is out of proportion to any legitimate interest of the affected party may interested party. This decision doesn't overturn the Dunlop test but reformulates the test and allows the court to look at the wider interests of the affected party (while still taking the Dunlop principles into account). New Guidance on Contractual Penalties looks at this in more detail.
The courts are generally reluctant to strike down LD provisions as a penalty, and it would probably be fair to say that so long as a LD has been agreed between 2 commercial parties the courts are unlikely to strike down the provision.
Do LDs still apply even if the contract has already been terminated?
In Triple Point Technology Inc v PTT Public Company Limited [2021] UKSC 29, the Supreme Court clarified the operation of LD clauses when a contract is terminated before completion. It held that LDs for delay apply up until the point of termination and will still be enforceable after a contract has ended, and where the parties don't want this to be the case, the contract should include specific wording stating otherwise. This case emphasized the importance of clear drafting in LD clauses. Supreme court reinstates entitlement to claim liquidated damages in the event of termination considers this. It is now not uncommon for construction contracts to specifically provide that LDs will only apply until the point of completion, or if earlier termination.
Any other complications?
Parties should be careful of the impact of partial possession on LDs. Lots of contracts contain a provision for the proportionate reduction of the LDs (based on the value of the part of the works being partially possessed as against the total value of the works) – in practice, this may not "work" and will depend on the drafting of LDs – for example for student accommodation this may be expressed as £ x per bed per day but the relevant part may also include kitchens etc. The specific wording of the provision will be relevant (see Bramall & Ogden Ltd v Sheffield City Council [1986] 29 BLR 73 where LDs could not be proportionately reduced versus Mansion Place Ltd v Fox Industrial Services Ltd [2021] EWHC 2972 (TCC) where they could be). It is not necessarily the case that proportionate reduction is required and this will depend on the facts of the case (see Eco World - Ballymore Embassy Gardens Co Ltd v Dobler UK Ltd [2021] EWHC 2207 (TCC) where notwithstanding the contract not providing for proportionate reduction where there was partial possession the LDs were upheld).
Conclusion
Liquidated damages have a valid part to play in most construction contracts and the relevant level will depend on several things, including the value of a project, the sector (e.g. student accommodation - including loss that is not only limited to delays on the completion of the retail and office space). The proposed level of liquidated damages should be shared with a contractor early in the tender process as this will have an impact on both price and programme (as well as being relevant for the contractor's sub-contracting strategy). If contractors are not able to agree on LDs at a level that will adequately compensate a client for a delay to a project, there may be insurance solutions such as Delay in Start Up Insurance which can provide some additional/alternative protection.
If you would like further advice on liquidated damages, please contact one of our construction lawyers.
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