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Liquidated damages

This guide was last updated in August 2011.

Despite the emergence of best practice construction methods and development of computerised critical path programming, many construction projects will still overrun their original contract period. For an employer, a delay will mean that the asset being constructed will not be able to be used when originally intended. This may mean the employer has to incur additional costs or suffer a delay in receiving income from the project. For the contractor, delay to the completion of the project may result in a liability for delay damages to the employer.

As a result of these risks, most building contracts fix the damages that will be payable to the employer for late completion in advance. These are referred to as 'liquidated damages' (LDs).

Although it is worth remembering that liquidated damages can be used in other circumstances, this guide will focus on LDs for delay.

The importance of time in construction contracts

Extensive provisions are made in construction contracts for establishing the date by which a contractor must complete the work that it has agreed to perform. If no date is specified a 'reasonable time for completion' will normally be implied, based on the circumstances of the particular project.

Without a fixed completion date, LDs will not be chargeable. For this reason, construction contracts will include a fixed completion date which may be extended through extension of time provisions. Extensions of time have benefits for both parties.

From a contractor's perspective:

  • they cover delays that are neither the fault nor the responsibility of the contractor;
  • a contractor will not normally be liable to pay damages for delay if completion time is validly extended.

From an employer's perspective, extensions of time:

  • provide certainty as to how the completion date is to be fixed, and under what circumstances it may be adjusted;
  • are designed to protect a right to claim LDs for delay in relevant circumstances.

Requirements for a valid liquidated damages provision

To succeed in a claim contractual for damages, a party must establish:

  • that there has been a breach of contract;
  • that it has suffered loss;
  • that there is a causal connection between the breach and the losses that party wants to recover.

In complex construction contract disputes there can be many losses and breaches of contract which can make it extremely difficult to link a specified loss to a specified breach.

The benefit of a valid LDs clause from the employer's perspective is that it removes the need for the employer to prove its actual loss and to 'mitigate', that is take reasonable steps to avoid or reduce, the loss covered by the LDs clause. In fact, if the clause is valid and applicable, employers will be entitled to the specified LDs even if they have sustained no actual loss. From a contractor's perspective, LDs effectively act as a limit on its liability for delay.

Although the court will uphold LD clauses wherever possible, a risk still exists that a poorly drafted clause will be unenforceable. It is important to ensure that:

  • the clause is a genuine pre-estimate of any loss likely to be sustained, rather than a penalty designed to deter a party from breaching the contract in the first place. Under English law, unlike in some other jurisdictions, if the clause amounts to a penalty it is likely that it will be unenforceable;
  • there is a definitive date fixed by the contract from which damages can run;
  • any specific contractual procedures, such as giving written notice within specified time limits, have been complied with;
  • the employer has not waived the right to deduct or claim LDs;
  • if the contract is otherwise brought to an end, LDs will still be payable if appropriate.

Another way to lose the protection of LDs is to fall foul of the concept of prevention – the most common and effective defence against LDs. In short, a party cannot impose a contractual obligation on the other where it impedes the other party in the performance of that obligation. Given that construction contracts are complex, an employer needs to be wary to avoid falling into this trap.

Early use and partial possession

Partial possession is where an employer is allowed, with the consent of the contractor, to take possession of any part of the works. If the employer exercises this right then that part of the work is effectively deemed to be completed. Most standard forms of construction contract have clauses to reduce a contractor's liability for LDs proportionately if any part of the works is certified as complete before the contract is completed in full.

Early use is where an employer is allowed, with the consent of the contractor, to use or occupy part of the works before that part is deemed to be completed. Early use will leave the risk and responsibility for the site and the works with the contractor, and therefore the contractor's full liability for LDs as stated in the contract will continue. However if the employer delays or disrupts the contractor, the contractor may have a claim for loss and expense.

Key dates and sectional completion

All commercial projects, particularly large ones, may reach practical completion (PC) in stages. Sectional completion is best used where an employer wants the contractor to complete a defined part of the works so that it or another contractor can take over that section entirely. The contractor would not then be expected to carry out any further work to that section, although it would remain liable for defects.

The benefit to the contractor of sectional completion is similar to that of practical completion in that it is relieved of some of its contractual obligations, including insurance and a proportion of LDs. Most contracts will contain a right to have the works completed in sections, and a corresponding right for the contractor to expect a reduction in its LD liability.

Calculating LDs for sectional completion should be approached with even more caution than single LDs:

  • the sections should be clearly understood by all parties, and if possible the terminology used to refer to them should be consistent throughout the document;
  • separate dates for completion should be given for each section;
  • separate LDs should be stated for each section so that, when sectional completion is reached, the contractor's LD liability may be proportionately reduced accordingly;
  • the contractor's liabilities for failure to meet sectional completion dates should be made clear;
  • all other validity requirements, as stated above, also apply.

Where an employer wishes a project to be completed in sections, and this is addressed in the contract and respective rates of LDs are provided for, there is an issue when the date a section is commenced depends on the completion of a previous section. This is known as the 'cascading effect', and it was considered in a 2008 case between Liberty Mercian Ltd and Dean and Dyball construction. The court held that, where a retail project was divided into five sections with each given a fixed completion date, the contractor was liable for four weeks' delay on each section where this had cascaded down from a delay on the first section that was the contractor's fault. Otherwise, the judge said, Dean and Dyball would effectively be able to take advantage of its own wrong which led to the delay in the first place.

Where an employer takes on two or more contractors to carry out work on the same project under separate contracts, the overall completion of the works will similarly require that work carried out by each of the contractors is dependent on the actions of the others. Key dates can then be used so that a contractor's work, or part of it, is required to achieve a defined condition by a certain date without the works necessarily having to be complete.

The difference, therefore, between a key date and sectional completion is that a key date does not require completion of all the work in the defined area. However, a contract usually provides that an employer may seek to recover money from the contractor in the same way in either case.

Subcontracts and liquidated damages

To minimise exposure, many contractors will seek to enter into contracts with the subcontractors on substantially the same terms as their contract up the chain. Stepping down the main contract terms works well for most obligations, however attempting to pass down liability for LDs to subcontractors can be difficult.

The contractor's loss will have three main elements:

  • its own costs of delay - site costs, overheads, financing etc;
  • its liability for LDs under the main contract;
  • its other subcontractors' loss and expense.

The first two are fairly easy to estimate, but the effect of one subcontractor's delay on the progress and cost of the others is almost impossible to pre-estimate.  A number of the standard forms therefore avoid LD clauses, instead providing that the subcontractor must pay the contractor for its loss and expense resulting from the subcontractor's failure to complete on time. This loss and expense may include all three elements outlined above.

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