Challenging liquidated damages
The courts are increasingly reluctant to allow challenges to liquidated damages clauses, as liquidated damages are usually fully negotiated and agreed terms. In Philips Hong Kong Ltd v AG Hong Kong, Privy Council Appeal No.29 of 1991 (1993) 61 BLR 41, the Privy Council considered that a court must be careful not to set too stringent a standard and that what the parties have agreed should normally be upheld.
This trend is set to continue following the Supreme Court's decision in Cavendish Square Holding BV v Talal El Makdessi and ParkingEye Limited v Beavis [2015] UKSC 67: there is a reluctance to interfere with a rate of liquidated damages that has been negotiated between properly advised parties of equal bargaining power.
Typical arguments for challenging the validity of liquidated damages clauses include:
The clause lacks certainty
If there are doubts about what the clause means or what sort of breach is covered, the courts can hold that it is unenforceable. If there are doubts as to what a clause means the courts will apply the rules of interpretation set out in case law. (See in particular Investors Compensation Scheme Ltd v West Bromwich Building Society [1997] UKHL 28. For recent House of Lords authority on contract interpretation see Chartbrook Limited v Persimmon Homes Limited [2009] UKHL 38.)
The contractual mechanism is inconsistent and cannot be operated
It is important that provisions in the contract are completed in a manner that is consistent with the contract generally. For example, the entry for clause 2.32.2 in the Contract Particulars of the JCT Standard Building Contract, 2016 edition, requires insertion of a single figure for the amount of liquidated damages (e.g. '£1,000') and the period (e.g. 'week') to which this applies, in the case of a contract without sectional completion. If this entry is not completed strictly as intended, the interlinked provisions of clauses 2.32 (liquidated damages) and 2.33 (partial possession) may not function as intended and it may be possible to challenge the liquidated damages clause: see the previous comments in relation to Bramall & Ogden Ltd v Sheffield City Council [1985] 29 BLR 73.
The contract machinery has broken down
Contractors may argue that the contract completion date has fallen away because 'time is at large'. This can arise where the employer prevents the contractor from performing the contract, for example by not giving possession of the site, by varying the works, by giving late instructions, or in some other way interfering with the contractor's operations on site. Unless these actions are covered by an extension of time clause, the consequences of the employer's actions are that it will not be able to claim liquidated damages.
In order to prevent this arising, wide extension of time clauses are included in modern standard form contracts: for example, clause 2.29.6 of the JCT Standard Building Contract is a 'catch all' relevant event, which covers any impediment, prevention or default of the employer or persons for whom it is responsible.
Contractual conditions have not been met
Some contracts stipulate that certain conditions must be met in order for the liquidated damages to be due. For example, clause 2.32 of the JCT Standard Building Contract 2016 edition stipulates 3 conditions:
- the contract administrator must issue a non-completion certificate;
- the employer must notify the contractor of its intention to deduct or demand liquidated damages before the date of the final certificate; and
- the employer must serve a notice on the contractor no later than five days before the final date for payment, specifying that liquidated damages will be deducted or demanded for the delay period at the rate specified in the contract, or a lesser rate specified in the notice.
The courts view liquidated damages provisions as an agreement which both parties understood and accepted at the time of making the contract, and which are an efficient means of providing compensation for the employer without the need for lengthy court proceedings. However, as the employer benefits significantly from liquidated damages clauses the courts will generally expect the employer to follow the liquidated damages mechanism to the letter.
There are limits to this: the courts will only expect strict compliance with the liquidated damages clause itself. In Henia Investments Inc v Beck Interiors Ltd [2015] EWHC 2433 (TCC), a contractor under a JCT Standard Building Contract argued that a non-completion certificate was invalid because the contract administrator had not reached a decision on a claim for an extension of time under clause 2.28. This argument was rejected, on the basis that compliance with clause 2.28 was not one of the conditions listed in clause 2.32.
The Technology and Construction Court (TCC) adopted a similar approach in J Murphy & Sons Ltd v Beckton Energy Ltd [2016] EWHC 607 (TCC). This was a decision on an amended FIDIC ‘Yellow Book’ contract. Murphy argued that an engineer's determination under clause 2.5 was a pre-requisite to deduction of liquidated damages. The TCC rejected this, on the basis that clause 8.7 (which dealt with liquidated damages) had been amended and no longer referenced clause 2.5. Clause 8.7 was treated as a stand-alone provision, the operation of which was not subject to the engineer's determination under clause 2.5.
A similar result ensued in J Murphy & Sons Ltd v Beckton Energy Ltd [2016] EWHC 607 (TCC). Under an amended FIDIC contract, the engineer's determination was generally required before the employer could deduct from payments due to the contractor. However, this was not expressly stated to apply in the clause governing the deduction of liquidated damages, which could therefore be deducted without such a determination.
Where a contract sipulates that certain conditions must be met, they must be met in the correct order. Although Grove Developments Limited v S&T(UK) Limited [2018] EWHC 123 (TCC) more directly addressed the practice of 'smash and grab' adjudications, the case also addressed the defendant's argument that sufficient time is required between the warning notice for withholding or deducting liquidated damanges and the demand notice. In this case, the time of receipt between two notices had been around seven seconds. This, however, is irrelevant. The only requirement is that the notices are sent sequentially and in the correct order.
The rate of liquidated damages is a penalty
A liquidated damages clause will not be enforced where it constitutes a penalty. The burden of proof that a liquidated damages clause is a penalty lies with the contractor.
From a practical perspective, a surveyor who is involved in estimating the loss that would result from a breach of contract (and the additional financial burden that may be imposed in respect of any further legitimate business interest to be protected) should always keep written build-ups and records to show how the figure was calculated. These records may include professional advice about likely rental levels for the property, details of finance charges, advice regarding the cost of alternative premises and the like. This information may have been obtained to verify the feasibility of the project; if so, it is suggested that copies of such advice should be obtained and kept safely with the other documents relating to the liquidated damages estimate.