Setting the amount

There is no simple method of estimating the correct rate of liquidated damages. Each case must be examined individually. However, in most cases liquidated damages are likely to be based on one or more of the following:

1. loss of return on capital: substantial capital is inevitably locked up in any development. While the building remains incomplete, the employer is deprived of any return on this;
2. direct loss: paying rent on an existing or alternative building, while the new one is still being built; and/or
3. extended financing costs: additional interest incurred while the building remains incomplete.

When estimating the likely cost of a delay, it is necessary to look at each of these categories of loss. However, care must be taken to ensure that there is no double counting: for example, a building owner who suffers loss of rent would not additionally be entitled to claim for the loss of interest that he or she might otherwise have earned on the capital tied up in the development: that building owner's return on capital is the rent received.

Liquidated damages are usually expressed as a rate per week or in some cases, per day or month.

Loss of return on capital

Commercial clients enter into development projects with the aim of making a direct financial return from the new building. For example, hotel owners aim to make a financial return by letting rooms; retailers aim to make a financial return by selling products; and property companies aim to make a financial return by receiving rent.

Example: hotel

In the case of a hotel owner, the loss of return would, at its most simple level, be the amount that the hotelier would charge for the hotel rooms that have not been completed on time. However, in order to avoid future arguments, when setting a rate the hotelier should take into account factors such as occupancy levels and running costs.

So the rate of liquidated damages should reflect the likely occupancy rate and running costs, such as room cleaning, laundry, power, maintenance, wear and tear and so on.

Hotel occupancy may vary dramatically across the year. For example, a hotel may expect 100% occupancy in the summer months but only 50% occupancy during the rest of the year. Such variances are often evened out into an average loss at any time of the year but there is no reason why a liquidated damages rate should not be set at 2 different amounts. This could be £x per week for delays from October to March and £y per week for delays from April to September. Provisions allowing for 2 rates require particularly careful drafting.

Hoteliers sometimes suggest a rate expressed as £x per room per night. This approach is problematic and should be avoided: see the comments below in respect of Bramall & Ogden Ltd v Sheffield City Council [1985] 29 BLR 73.

Example: retailer

Many retail businesses make most of their profit in the Christmas trading season. The liquidated damages for the 6 weeks leading up to Christmas may be set at a different rate to the liquidated damages for the rest of the year.

Again, provisions allowing for 2 rates require particularly careful drafting: a provision for a higher rate of liquidated damages in the Christmas trading season has been struck down in arbitration on the basis that it did not revert to the lower rate come January. For this reason, variable rates are not the norm and, unless the difference is very significant, the simplicity of a single rate is usually preferred.

Example: property companies

Liquidated damages for pre-let developments, or those for which there is ready demand, such as a build to let residential development, are often based on loss of rental income.  In the latter case, the rate should take account of any likely void periods.

The landlords of residential development may wish to express the rate of liquidated damages as a figure per house (or apartment) per day or week. The rates may vary to reflect the varying losses associated with house or apartment types of different value.

Bramall & Ogden Ltd v Sheffield City Council [1985] 29 BLR 73 demonstrates that extra care must be taken with any rate that is expressed as an amount 'per unit per day/week'. In a contract for construction of a housing estate, which did not provide for sectional completion, the rate was expressed as '£20 per week for each uncompleted dwelling'. This arrangement failed, as it was not consistent with the partial possession provisions in the JCT building contract. Under these provisions, the rate of liquidated damages is to be reduced pro rata to the value of any parts which are completed and taken over by the employer, and this dictates use of a single overall rate of liquidated damages. Under the JCT forms of contract, if there is a wish to specify a rate per unit, per day or week, then the sectional completion arrangements must be used.

A problem may exist with rates per unit where the development includes significant common areas, such as roads and sewers and/or lifts, bin stores and walkways, for which there is no separate liquidated damages provision. In these cases the rate per unit must be deemed to include a proportion of the common areas.

Direct loss

The most frequent direct additional cost incurred if a new building is delayed is rent paid on an existing building or for temporary accommodation.

For example, a business may need to stay in its existing premises for a longer period due to late completion of the new premises. If the old premises are rented from a landlord, the liquidated damages may be calculated on the cost of extending the rental period.

Most liquidated damages rates are expressed as an amount per day or per week but if the main loss is the monthly cost of building rental it follows the liquidated damages could also be expressed in an amount per month, or part thereof. If a school cannot move into a new building except during term breaks the liquidated damages may be levied per school term, or part thereof.

Other direct costs would include those of a school that is required to pay for the delivery, erection and later dismantling and removal of temporary classrooms; a university that must put students in hotel accommodation if a new hall of residence is completed late, or a manufacturer that must continue to buy in electricity because of delayed completion of a renewable energy installation.

The costs in each case must be considered and assessed as accurately as possible. Some averaging of likely daily or weekly cost is inevitable in most cases.

On many projects the employer will incur additional fees from the professionals managing the delayed project. A project manager or architect will have to spend additional time on site and a quantity surveyor will have to undertake more valuations than originally allowed and these professionals will expect to be reimbursed their additional costs. These types of additional cost should be included in the liquidated damages rate.

Additional losses may also be anticipated for storing new equipment and/or furniture for the new building, so such storage costs should be included in the calculation of liquidated damages.

Extended financing costs

Most development projects are financed using borrowed money and if the project is late the charges for borrowing will run for a longer period.

Conversely, if the project is financed out of the employer's own capital then, if the project is late, the employer will suffer a loss of the interest that could have been earned on that capital during the delay period.

These losses are likely to affect most projects and they will be particularly important to a commercial developer who is planning to sell the completed project.

For example, a developer of an apartment block will incur additional financing costs if the works are delayed, because they will not be able to sell the apartments until the works are complete, and this is likely to erode profits. It is possible that a delay during a period of high property inflation may actually mean that a developer ultimately sells the apartments for more than they would have been able had the completion not been delayed but that is not something that can be predicted and allowed for when estimating the likely cost of delay.

It may appear to be a relatively easy task to estimate the loss due to extended finance costs but the rate of interest for borrowing (or the rate of lost interest on savings rates) may well change, possibly significantly, between the time the pre-estimate for liquidated damages is carried out and the date when the delay occurs. In most cases, the assumption will be that the rates of interest current at the time of the estimate will be the same as the rates when the delay occurs.

One problem with assessing additional finance costs is that such costs will be incurred in any event, and whilst a delay will extend the period during which they are payable it will also delay expenditure on finance charges: a project that is only 75% complete at the contract completion date will only have required 75% financing drawdown (not 100% as envisaged at the outset). This should be taken into account when setting the rate of liquidated damages. Consequently, the loss caused by delay is not simply the amount of finance for the whole project multiplied by the interest rate multiplied by the period of delay: an assessment must be made of the likely additional cost taking into account the costs that would have been incurred in any event and the anticipated drawdown profile.

Sectional completion

Under most standard form contracts, there is provision for a sectional completion option.  If the contract provides for sectional completion, it is usual to estimate the loss for each section and to have a separate liquidated damages rate for each section.

The assessment and application of liquidated damages to sections is the same as the assessment and application to the contract as a whole.