Challenging liquidated damages

If a court holds that a liquidated damages clause is unenforceable the employer may still have a remedy in the form of general damages unless the employer has waived their rights in this regard. This can arise, for example, by stating the rate of liquidated damages in the contract particulars section of a JCT Contract as '£ NIL' (see comments below on Temloc v Errill Properties).

When a liquidated damages clause is held to be a penalty then there may be a question whether the sum stipulated is an upper limit on the damages recoverable as general damages. It has been suggested that this depends on the reason why the liquidated damages were unenforceable: only if the liquidated damages clause fails as a penalty or because time is at large will the claim for common law damages will be capped.

Drafting liquidated damages

Poor drafting of a liquidated damages clause can lead to difficulties when the employer tries to enforce it. The clause must be clear and unambiguous.

When drafting a liquidated damages clause the following points should be considered:

Certainty of specified amount of liquidated damages

The specified amount should reflect a reasonable pre-estimate of the loss the employer will suffer if the contractor breached its obligation together, in the appropriate case, with a commercially reasonable figure representing the 'additional financial burden' required for protection of any other legitimate commercial interests of the employer.

Care must be taken to stipulate exactly what the amount is and the mechanics for calculating it - in the case of delay, it should be an amount based on a periodic calculation (i.e. £x per week or part thereof) and not a lump sum.

Any attempt to exclude liquidated damages and/or general common law damages must be made clear. In Temloc Ltd v Erril Properties Ltd (1987) 39 BLR 30, the parties specified in the contract particulars of a JCT contract that liquidated damages would be '£nil', but did not delete the liquidated damages clause itself. The court held that this meant the employer had waived its right to liquidated damages and also could not pursue the contractor in the courts for unliquidated damages.  The logic was that the liquidated damages clause continued to apply, albeit with a nil rate, thus there could be no claim for general damages.

In contrast, in an Australian case, Silent Vector Pty Ltd t/as Sizer Builders v Squarcini [2008] WASC 246, the parties had inserted 'N/A' next to the clause relating to liquidated damages. The judge agreed with the arbitrator that a reasonable person would believe that there is a distinction between 'N/A' and 'NIL'. The judge held that the inclusion of 'N/A' beside this clause indicated that the entire liquidated damages clause was no longer applicable to the contract, and that a claim for general damages could still be brought.

Set out mechanism by which liquidated damages become payable

This includes setting out the mechanism which the employer must follow in order to validly claim liquidated damages - for example, a certificate of non-completion followed by a notice stating the amount of liquidated damages which is to be withheld.

To protect both parties, the contract must also provide a valid mechanism by which the contractor can be awarded an extension of time including stipulating the types of events which can lead to the granting of an extension of time. If there is no provision for granting an extension in respect of delays caused by the employer, the 'prevention principle' will apply and the employer is likely to lose the right to apply liquidated damages.

However, in the absence of an express provision the fact that the extension of time provisions have not been fully applied will not invalidate the deduction of liquidated damages: see Challenging liquidated damages for comments on Henia Investments Ltd v Beck Interiors Ltd.

In some forms of JCT contract, granting an extension of time will have the effect of cancelling the previous certificate of non-completion. The contract administrator will then need to issue a further certificate. In Octoesse LLP v Trak Special Projects Ltd [2016] EWHC 3180 (TCC), the contract administrator failed to re-issue a further certificate after a 9.5 week extension of time was given. The court held that it is always necessary to issue a further certificate of non completion if the contractor does not complete the work by the extended completion date and in the absence of a new certificate Octoesse were not able to deduct liquidated damages.

Sectional completion

Special provisions are needed where contractors are required to complete the works in sections and to hand over each section to the employer as it is completed. In such situations the contract should stipulate an amount of liquidated damages for each section defined in the contract and which reflects the likely cost to the employer of that particular section not being completed on time.

Equally, it should be made clear whether the contractor is liable for each delay on a per section basis or whether, when a delay on one section affects the completion of another, the contractor is liable for a 'cascade' of liquidated damages.

If the employer wishes to take partial possession of the site, the contract should provide for a reduction in the amount of liquidated damages pro rata to the value of the part of the works that has been taken over by the employer. In Stanor Electric Ltd v R Mansell Ltd [1988] CILL 399, a single rate was specified in a contract for the construction of 2 houses. One house was delayed, but as there was no mechanism for reducing the single rate in these circumstances, the single rate of liquidated damages was treated as an irrecoverable penalty.

Great care must always be taken to ensure that the liquidated damages clause is consistent with the partial possession arrangements in the contract (see Bramall & Ogden Ltd v Sheffield City Council [1985] 29 BLR 73.

Payment of liquidated damages mechanism

The employer must have the right to deduct the amount of liquidated damages from any interim payment due to the contractor as well as the right to claim the amount from the contractor if no further payments are due. This should be expressly stated in the liquidated damages clause.

Record of negotiations

As with all contractual negotiations a record should be kept of how the liquidated damages clause was negotiated and agreed, including any information on how the pre-estimate was reached.