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A Guide

Practical insights on liquidated damages provisions in construction contracts, including recent case law developments and key considerations for negotiating effective clauses.

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The Fundamentals

Definition and Purpose

Liquidated damages are predetermined amounts payable for specific breaches of contract, typically delays in completion. They provide certainty by stipulating compensation regardless of actual loss suffered.

Commercial Benefits

These provisions eliminate the need for employers to quantify losses, which can be difficult and costly. They also allow contractors to manage financial risk by limiting exposure to otherwise unknown liabilities.

Common Applications

While most frequently associated with project delays, liquidated damages are also used in process engineering and power projects where performance specifications are not met.

Liquidated Damages

Legal Test: Penalties vs. Enforceable Liquidated Damages

Dunlop Tyre Case (1915)

Established the traditional test focusing on whether the provision was a genuine pre-estimate of loss rather than a penalty.

Makdessi Case (2015)

Supreme Court shifted emphasis to whether the provision imposes a detriment "out of all proportion" to the innocent party's legitimate interest.

Current Position

Strong presumption favouring enforcement of liquidated damages in commercial contracts between advised parties of comparable bargaining power.

Strong Presumption of Validity

Courts uphold bargains between commercial parties

Legitimate Interest Test

Must serve a purpose beyond mere punishment

Proportionality Requirement

Not extravagant or unconscionable

Traditional Dunlop Tyre Guidance

Genuine pre-estimate of loss vs. penalty

The Supreme Court in Makdessi emphasised that the true test is whether the provision "imposes a detriment on the contract-breaker out of all proportion to any legitimate interest of the innocent party." The historical Dunlop tests remain useful but no longer exclusively definitive.

Case Study: Eco World v Dobler (2021)

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Contract Background

EWB engaged Dobler for façade works across Blocks A, B and C with no provision for sectional completion. The contract contained a single liquidated damages rate.

Partial Possession

EWB took possession of Blocks B and C on 15 June 2018, with practical completion of Block A certified on 20 December 2018.

Full Liquidated Damages

EWB applied the full liquidated damages rate despite only part of the works remaining incomplete, leading to Dobler's challenge.

Court Decision

The court upheld the liquidated damages provision, finding it was not a penalty despite no mechanism for reduction upon partial possession.

Judicial Analysis in Eco World

Contract Interpretation Approach

Mrs Justice O'Farrell emphasised that contracts must be interpreted by reference to what a reasonable person with all available background knowledge would understand from the language used, focusing on the natural and ordinary meaning in documentary, factual and commercial context.

Commercial Reasonableness

The court found the liquidated damages provision was "not unconscionable or extravagant" and noted four key factors supporting its validity: both parties had legal advisers; the provision served legitimate commercial purposes; EWB had legitimate interest in timely completion; and calculation of partial damages would be difficult.

Cap on Liability

Even if the liquidated damages provision had been void (which it wasn't), the court stated it would have upheld the overall cap on delay damages in the same clause, reinforcing the theme of party autonomy and freedom of contract.

Triple Point Supreme Court Decision: Liquidated Damages on Termination

The Supreme Court in Triple Point overturned the controversial Court of Appeal decision, reinstating the orthodox position that liquidated damages accrue up to termination, after which any damages must be claimed as general damages. Lady Arden stated the Court of Appeal had "thrown out the baby with the bathwater" in its previous ruling.

Pre-termination period

Liquidated damages accrue normally

TERmination point

Cuts off liquidated damages entitlement

Post-termination period

General damages apply instead

Key Lessons from Recent Case Law

Liquidated Damages Provisions Likely to be Upheld

The Makdessi test as applied in Eco World suggests courts will be increasingly reluctant to invalidate liquidated damages provisions, especially between commercial entities with legal representation.

Partial Possession Requires Clear Mechanisms

Without express provisions for reducing liquidated damages upon partial possession, courts may enforce the full rate as drafted. Contractors should ensure appropriate reduction mechanisms are included.

Genuine Pre-estimate Still Best Practice

Though no longer the exclusive test, maintaining contemporaneous calculations demonstrating pre-estimates of loss provides a solid foundation for enforceable liquidated damages provisions.

Termination Position Now Clarified

The Supreme Court's Triple Point decision confirms the orthodox position that liquidated damages accrue until termination, after which general damages apply.

Practical Implications

Drafting Considerations

Increased likelihood of enforceable provisions

  • Maintain contemporaneous pre-contract loss estimates

  • Consider including stepped rates for partial possession

  • Review applicability of sectional completion provisions

Financial Planning

Budget for potential liabilities

  • Factor liquidated damages into project contingencies

  • Consider overall liability caps

  • Assess impact on project cash flow

Risk Assessment

Greater scrutiny required

  • Assume liquidated damages will be enforced

  • Thoroughly assess rate implications

  • Don't rely on penalty arguments as protection

Bargaining Position

Courts favour party autonomy

  • Equal bargaining power reduces court intervention

  • Professional legal advice strengthens enforceability

  • Mere unfairness insufficient to invalidate provisions

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For Employers

Maintain contemporaneous calculations showing pre-estimates of loss to justify liquidated damages rates. Courts will likely uphold provisions where both parties had legal advice and equal bargaining power.

For Contractors

Carefully review liquidated damages provisions, especially regarding partial possession and sectional completion. Mere unfairness is insufficient to challenge provisions; they must be "out of all proportion" to be deemed penalties.

For Both Parties

No need to expressly address termination effects on liquidated damages following Triple Point, as the Supreme Court confirmed damages accrue until termination date.

Practical Considerations

Review Existing Contracts

Analyse liquidated damages provisions in light of recent case law. Pay particular attention to any provisions influenced by the now-overturned Court of Appeal decision in Triple Point, which may require clarification.

Risk Mitigation Strategies

Develop comprehensive delay risk assessments and mitigation plans. Include contingency planning for potential liquidated damages exposure, especially for projects with tight completion deadlines or complex sectioning requirements.

Negotiation Priorities

Focus on securing appropriate stepped rates for partial possession or sectional completion. Consider overall caps on liquidated damages liability and ensure clarity on how the provisions interact with other contractual mechanisms.

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