Construction contracts place emphasis on the insertion of clear dates for starting works, when the works must be completed by, and the provision for inserting dates that sections of the works must be completed by. Commercial factors drive this necessity for clarity on the timing of the works. The Contractor wants a back-stop date against which extensions of time can be measured, whilst the Developer wants certainty on when the project will be complete and ready for use e.g. a stadium opening for the new season, a shopping centre allowing tenants access for fit out, a railway station allowing train operating companies to meet their timetables.
Things do not always go according to plan: projects complete late, costs are incurred, and disputes arise around the recovery of costs.
If a project is not completed by the contractual completion date, the Developer can make a claim for general damages due to a breach of contract. In this situation, the Developer must prove that a breach has occurred, that such a breach caused them to incur losses, and then prove the amount of the loss and demonstrate they have acted reasonably in mitigating the impacts.
Alternatively, the Developer can recover damages via Liquidated and Ascertained Damages or “LADs”, sometimes referred to as LDs or delay damages. Liquidated and Ascertained Damages are an agreed, pre-determined, amount that is payable in respect of the breach occurring until the works are fully complete. The benefit of Liquidated and Ascertained Damages is that they are payable upon the breach occurring, the Developer is not required to prove their loss and to an extent they provide the Contractor with a cap on their liability. Managing damages in this way can avoid court and other dispute resolution proceedings taking place.
Liquidated and Ascertained Damages are generally stated in contracts as an amount per week but can be stated as per day or, in the extreme, per hour or per minute in the case of major railway projects for example. Whatever the case may be, the amount stated should be pre-agreed before entering into contract and must also be a genuine representation of the loss the Developer is estimated to incur. The reason for this is that recovery of Liquidated and Ascertained Damages puts the Developer back into a position as if the breach had not occurred.
Liquidated and Ascertained Damages are not intended to be a penalty or profit generator. If the amount stated is more than any loss the Developer is likely to incur, they could be challenged through the courts as being arbitrary and a penalty and therefore unenforceable.
In estimating the rate of Liquidated and Ascertained Damages, the Developer needs to consider the likely losses they will incur in the event the project runs past its completion date. Factors to consider will include any fines imposed by third parties, loss of income from delayed use of the building, any legal fees they will incur in managing third party delay costs, the loss of rent from tenants, and their own finance costs incurred due to delayed use. They should then keep a record of how they arrived at the rate in case they need to substantiate their position under challenge through the courts by the Contractor.
When drafting JCT contracts, there must be a date inserted from when the delay damages can be assessed. The damages can then be applied from that date until the point that practical completion is achieved. In the absence of a fixed completion date at the outset, Liquidated and Ascertained Damages cannot be levied.
The Developer must follow a process of notification before imposing Liquidated and Ascertained Damages in under JCT Contract. Failure to follow this process means Liquidated and Ascertained Damages cannot be charged:
- Firstly, the Developer must issue a non-completion notice stating that the works did not complete on time. For example, under a JCT Design and Build Contract, this would be under Clause 2.28
- Secondly, the Developer must issue a notice that they may require payment, withhold or deduct Liquidated and Ascertained Damages. For example, JCT Design and Build Clause 220.127.116.11.
- Thirdly, the Developer issues a notice requiring payment of Liquidated and Ascertained Damages or withholding or deducting them. For example, JCT Design and Build Clause 2.29.1.
Good practice is for the Contractor to step down Liquidated and Ascertained Damages provisions into their sub-contracts where they the Contractor estimates their own costs and the Liquidated and Ascertained Damages that the Developer will impose.
With projects involving multiple subcontractors it can be very difficult to establish who the dominant delay resides with and, therefore, which subcontractor should be charged the Liquidated and Ascertained Damages. If the same level of Liquidated and Ascertained Damages plus the Contractors own costs are inserted into every subcontract, the rate will likely be so high that you are likely to end up with zero tender returns, or conversely face claims that the Liquidated and Ascertained Damages are penalties and not representative of true losses. For this reason, it’s often prudent to omit Liquidated and Ascertained Damages from the subcontracts and in the event of a breach make a claim under general damages.
How not to operate LADs?
As noted above, the rate of Liquidated and Ascertained Damages should be representative of the estimated losses the Developer will incur in the event of a breach. There are many examples of court cases where it has been proven the rate of delay damages is a penalty and therefore not commercially justifiable. The outcome in these instances is the Liquidated and Ascertained Damages are not enforceable and a claim for general damage comes into play along with all the obligations above in terms of establishing liability.
Some more common issues in terms of drafting contracts can be where a standard form is completed and the space for entering the rate of damages states ‘Nil’ or ‘Not Applicable.’ In this instance, the Developer doesn’t want to utilise the option for Liquidated and Ascertained Damages, but by inserting such words it can be construed that the Contractors entire liability for damages, be it general or Liquidated and Ascertained Damages, is zero. The way to deal with such an issue is to delete the relevant contract clauses or put ‘not used’ when drafting.
Where a cap on the level of Liquidated and Ascertained Damages is inserted in the contract, for example capped at a percentage of the contract value or a fixed sum, the Developer or Contractor is exposed to losses they are subsequently unable to recover in full. If this event occurs and if the Developer is faced with a significant delay, and therefore liability, one possible solution is to terminate the contract and re-tender the remaining works with a new Contractor.
Liquidated and Ascertained Damages and Extensions of Time
Contracts need a fixed completion date or else Liquidated and Ascertained Damages will not be chargeable as there is no baseline from which to measure a breach. However, it is possible for this fixed date to be extended through claims for an extension of time.
If a Contractor can demonstrate entitlement where delays are not their fault and therefore not their responsibility, they can be granted an extension of time and relief from delay damages. An example of this could be failure by the Developer to provide something by the date shown on the programme that ultimately lead to a delay.
From a Developers point of view, they should administer the contract such that all parties remain clear on their obligations and there is no ambiguity over when the project should be completed.
The Developer should take care to avoid any maladministration of the programme such as failing to provide instructions, changing the sequence of the works, allowing third party contractors onto site early, but above all not acknowledging entitlement. The reason for this is that if later down the line they wish to levy Liquidated and Ascertained Damages, the Contractor can argue that their programme has been impeded beyond their control and therefore time is generally at large and they can complete the works in a reasonable timeframe. Such circumstance could make applying Liquidated and Ascertained Damages invalid.
Liquidated and Ascertained Damages and Partial Completion
As projects near completion, for example a shopping centre, the pressure from the Developer will be to enable their tenants’ early access and allow for shop fitting and potentially open for trading early. In the event that this is feasible, the Developer will be deemed to have taken over that section of the works and is therefore liable for it. The Contractors rate for Liquidated and Ascertained Damages should be reflective of their decreased liability as parts of the work have essentially achieved practical completion.
Failure to have adequately drafted sectional completion provisions, or if the Developer decides to change the handover sequence of the works but not amend the Liquidated and Ascertained Damages, could put the entire Liquidated and Ascertained Damage provision at risk of uncertainty and therefore make them null and void.
If this type of handover is known about at the start of the project, sectional completion provisions can be drafted into the contract with suitable levels of Liquidated and Ascertained Damages applied to each section. However, be aware that when drafting there may be a cascade effect if sections are not completed in a certain order and therefore weighting should be considered in the drafting.
Liquidated and Ascertained Damages – Case Law
There is an abundance of case law involving Liquidated and Ascertained Damages with decisions going either way in many cases. One of the more interesting subject areas is whether Liquidated and Ascertained Damages can be applied after a contract has been terminated.
For example, a Contractor was running significantly late with little sign of improved performance, so the Developer terminates the contract and replaces the Contractor. However, the Developer wishes to hold the original Contractor liable for Liquidated and Ascertained Damages until such point that practical completion has been achieved. The line of argument in regards holding the original Contractor to account is that by relieving them of damages they have been rewarded for their own default.
In the case of Hall vs Van Der Heiden, Mr Justice Coulson stated:
“I reject the submission that the defendant’s liability to pay liquidated damages somehow came to an end when his employment under the contract was terminated. There is no such provision in the contract.”
Despite the above, this runs in direct contradiction this to the case of Shaw & Anor vs MFP Foundations and Pilings Limited, where Mr Justice Edwards-Stuart stated:
“After the date of termination, the parties are no longer required to perform their primary obligations under the contract and so the contractor’s obligation to complete by the completion date no longer remains and the provision for liquidated damages therefore becomes irrelevant.”
As recently as March 2019 and in the case of Triple Point Technology Inc. vs. PTT Public Company Ltd, the latest ruling by Sir Rupert Jackson stated:
“In my view, the question whether the liquidated damages clause (a) ceases to apply or (b) continues to apply up to termination/abandonment, or even conceivably beyond that date, must depend upon the wording of the clause itself. There is no invariable rule that liquidated damages must be used as a formula for compensating the Developer for part of its loss.”
The case of El Makdessi vs Cavendish Square Holdings (2013) demonstrates the requirement for Liquidated and Ascertained Damages to reflect a reasonable estimate of the Developer’s true losses. In this case, the Court of Appeal found that the damages clause was a penalty and not enforceable. The purpose of the damages was a deterrent to finishing late as opposed to being truly reflective of the Developers losses.
In contrast, the Dunlop Pneumatic Tyre Co Ltd vs New Garage and Motor Co Ltd is treated as a significant case within the construction industry due to the fact the liquidated damages in question were challenged but ultimately not viewed as a penalty. They were held as a “genuine pre-estimate” of loss by the House of Lords.
The Liquidated and Ascertained Damages are commonly used to protect the Developer’s commercial interests and to provide an incentive for Contractors to complete on time. However, they can also drive adverse behaviours such as the Contractor fixating on gaining extension of time awards to protect themselves rather than focusing on the job at hand.
What should be considered alongside Liquidated and Ascertained Damages are other incentives for Contractors to complete the works on time or to simply minimise delays. These measures could include a suitable level of time risk allowance in their programme or, in the event of delay, undertaking a cost benefit analysis regarding acceleration costs vs delay damages to make informed decisions. Alternatively, by simply employing performance-indicating tools, such as earned value management to offer early signs of performance, issues enabling corrective action in good time.