Liquidated Damages
Having your cake and eating it
IN the recent case of Eco World – Ballymore Embassy Gardens Company Ltd v Dobler UK Ltd (2021) EWHC 2207 (TCC) the English Technology and Construction Court (TCC) found that an employer was entitled to claim the full amount of liquidated damages payable upon contractor delay, notwithstanding the fact that it had taken partial possession of the contractor’s works.
The decision, which may come as something of a surprise to contractors and employers alike, demonstrates that ultimately all depends on the wording of an individual contract.
Background
Liquidated damages can be a powerful tool in construction contracts. The usual position, when a party claims that a clause in a contract has been breached, is that it must prove that it suffered loss as a result of that breach and then quantify that loss. In the case of delays to construction projects, this has the potential to be a complicated, drawn-out exercise leading to expensive disputes. Liquidated damages, on the other hand, are payable without proof of loss. The innocent party must generally only prove that the works have not been completed by the contractual completion date to be entitled to liquidated damages at the agreed rate. The resulting certainty and predictability benefits both contracting parties.
Given the comparative ease with which liquidated damages can be claimed (as compared to establishing and proving actual loss), the party levying them will always be in a position of power. For this reason, the courts have developed certain rules designed to prevent that power from being abused. One of these is that liquidated damages cannot be set in such a way that they constitute a penalty.
Given the comparative ease with which liquidated damages can be claimed (as compared to establishing and proving actual loss), the party levying them will always be in a position of power.
Another significant caveat is that where liquidated damages are agreed in respect of certain breaches, they are to be an exhaustive remedy for any losses arising from the relevant breach (i.e. the innocent party forfeits its rights to claim general, or ‘unliquidated’, damages). Importantly, liquidated damages are not enforceable unless they are certain – the parties must know in advance, in real terms, what the actual amount of liquidated damages will be if the project is delayed.
In construction projects, employers may also be granted the right to take over parts of a contractor’s works early. In some cases, employers who do so proceed to levy liquidated damages at a reduced rate that takes this partial possession into account. Other employers, however, may attempt to levy liquidated damages in respect of the whole of the works without making an allowance for the parts that were taken over early. Such conduct has traditionally been thought to be impermissible, as it essentially involves an attempt by employers to ‘have their cake and eat it’ – enabling them to limit their loss by progressing the part of the works they have taken over, while at the same time purporting to levy liquidated damages at a rate designed to compensate them for the loss they would have suffered if the works as a whole were delayed.
The facts
Dobler UK was engaged by Eco World to carry out design, supply and installation of the façade and glazing for a residential building in Nine Elms, London. The building was broken down into three separate blocks – A, B and C. None of the blocks were completed by the completion date set out in the contract, but in due course Dobler finished its works in respect of blocks B and C, and Eco World took them over.
It was clear from the leading textbooks that, in general, liquidated damages will fail in such circumstances unless there is an effective mechanism for dividing the single sum of liquidated damages by completed sections.
Several months later, block A was completed and taken over. When Eco World issued its assessment of the final payment due to Dobler, it withheld liquidated damages from the final payment without making any allowance for the fact that it had taken over two of the three blocks well in advance of the third.
The contract contained no mechanism providing for different rates of liquidated damages in circumstances where some of the blocks had been taken over prior to completion. Instead, as long as the works as a whole had not been completed by the required date, the full rate of liquidated damages would become due.
Somewhat unusually, as a result of a cap on liquidated damages in the contract, by the time the dispute came before the TCC, Eco World’s position was that its own decision to levy liquidated damages was wrongful, as the liquidated damages provision was void and unenforceable (thus enabling it to claim uncapped general damages for delay), while Dobler argued that its only liability in damages was pursuant to the liquidated damages clause.
The decision
Eco World argued that the liquidated damages regime was void for want of certainty as it was not possible to calculate a reduced rate of liquidated damages to reflect the fact that parts of the works had been taken over early. While it was clear that the contract allowed Eco World to take over parts of the works early, what was missing was a corresponding provision that made it clear how the liquidated damages were to be reduced in those circumstances. There was insufficient certainty, for instance, because Dobler could not know in advance how such a reduction was to be calculated (for example, a pro rata reduction in liquidated damages reflecting how many rooms in a building had been completed relative to the total number would produce a different result to a calculation based on the amount of completed floors or square metres).
It was clear from the leading textbooks that, in general, liquidated damages will fail in such circumstances unless there is an effective mechanism for dividing the single sum of liquidated damages by completed sections. The TCC noted, however, that “it is important not to elevate statements of general principle into an inflexible rule of law.” While the TCC was referring to a number of cases in which liquidated damages were invalidated by an employer’s early possession, the liquidated damages clauses were invalidated only because the contracts in those cases were unclear or inconsistent as to what the consequences of that early possession would be; in other words, the authorities did not provide that an employer’s decision to take partial possession was ‘automatically fatal’ to its right to levy liquidated damages.
The key question, in the TCC’s view, was whether the relevant provisions could be operated with sufficient certainty so that it was clear, in real terms, what the consequences of partial possession were on the rate of liquidated damages payable.
The authorities did not provide that an employer’s decision to take partial possession was ‘automatically fatal’ to its right to levy liquidated damages.
On the specific wording of the contract between Eco World and Dobler, the TCC found that the liquidated damages clause was not invalidated by Eco World’s decision to take partial possession. While there was no provision made in the contract for calculating a reduction in liquidated damages in that scenario, neither had Eco World purported to make such a reduction. In this regard, the contract was clear that (i) Eco World was entitled to take over parts of the works before others, as it did; and (ii) early possession of those sections had no consequences in terms of the liquidated damages. It was clear from the express terms of the contract that Dobler would be liable for the full rate of liquidated damages once completion was delayed, until such time as all of its works were completed. Regardless of whether this arrangement was fair, it was nonetheless the case that the relevant clauses could be operated with certainty.
Given that these provisions were clear on their face, Eco World advanced a fall-back argument that the liquidated damages regime amounted to an unenforceable penalty, when read together with the provisions entitling it to take partial possession. Eco World essentially argued that it was inherently unfair for it to be able to levy the same amount of liquidated damages in respect of one, two or all three blocks, given that different levels of loss would be incurred, particularly in circumstances where the contract also allowed it to take over blocks early.
The case law was clear, however, that in order for an liquidated damages provision to be unenforceable, it must be shown to be unconscionable or so extravagant as to amount to a penalty. The fact that it is not a genuine pre-estimate of loss does not necessarily mean that it will be a penalty, even if it is intended to act more as an incentive to complete on time.
Indeed, one of the reasons for the existence of liquidated damages provisions in the first place is that quantifying loss in these circumstances can be extremely difficult. In this case, any combination of delays, or partial delays, to the blocks could have resulted in differing levels of loss to Eco World given the different stakeholders involved. The liquidated damages provision was negotiated by the parties with the benefit of advice from external lawyers and the TCC noted that, in those circumstances, it should be cautious to interfere, particularly in circumstances where it was not suggested that the rate of liquidated damages was so high as to be considered unreasonable or disproportionate.
Although not necessary for the court to determine, Dobler also argued that even if the liquidated damages clause became inoperable due to Eco World’s early possession, this inoperability could be cured by an implied term. The liquidated damages clause gave Eco World the discretion to claim liquidated damages at a lesser rate than that set out in the contract, which Dobler argued gave rise to an implied term of reasonableness, and said that any reasonable exercise of Eco World’s discretion would involve a reduction of liquidated damages by way of a fairly simple calculation reflecting the parts of the works that had been taken over early. The TCC was not prepared, however, to imply such a term, as the express terms of the contract were already clear and implying such a term would cut across the express allocation of risk that the parties had agreed on when the contract was formed.
Finally, the TCC noted that even if the liquidated damages clause had been held to be unenforceable in itself, the contractual cap on liquidated damages would nonetheless have applied to limit the level of any general damages. This was because, in the TCC’s view, the parties had demonstrated a ‘clear intention’ to limit Dobler’s liability for delay to the agreed level, even if this intention was originally arrived at in the context of setting the limit of liquidated damages and a literal reading of the relevant clause would confine the limit to liquidated damages.
Comment
The TCC’s decision may come as a surprise to many in the industry who have been operating under the assumption that, as far as liquidated damages and early possession are concerned, employers generally cannot have their cake and eat it, unless there are very clear provisions to the contrary.
It is beyond doubt that an undefined discretion on the employer’s part to lower the rate of liquidated damages due is not sufficient.
Nonetheless, it must always be emphasised that the specific wording of the contract will always be determinative. As illustrated by the raft of cases in which liquidated damages have been held to be unenforceable in very similar scenarios, to ensure certainty an liquidated damages regime should leave no room for doubt when it comes to the effect of partial possession.
It remains the case that employers should take extreme care, prior to any partial taking over, to review the contract carefully and ensure that the liquidated damages regime they have agreed to allows them to take over part of the works without waiving their right to claim liquidated damages – or that it contains an express mechanism allowing for a reduction in liquidated damages to be calculated with certainty, if such a reduction is intended by the parties. It is beyond doubt that an undefined discretion on the employer’s part to lower the rate of liquidated damages due is not sufficient; the contract must expressly provide, for instance, for completion in sections, and specify the rate of liquidated damages that will become payable for each particular section that may be delayed.
In order to reduce the likelihood of disputes, both employers and contractors are encouraged to provide for as much certainty as possible in advance. If either party envisages early taking over to be likely in respect of any parts of the works, it is advisable to agree to a liquidated damages regime that makes it clear what the consequences of such a take-over will be. It will be a source of comfort to contractors, however, that the courts will likely uphold a clear intention to limit liability to a certain level, even if an liquidated damages regime otherwise fails.
Finally, the decision was notable in that it was one of the first judgments to cite the recent decision of the English Supreme Court in Triple Point Technology, Inc v PTT Public Company Ltd (2021) UKSC 29 as a leading authority on liquidated damages clauses.
Rebecca Williams, Partner and Elliot MacDonald, Associate (Foreign Qualified Lawyer), Watson Farley & Williams
rwilliams@wfw.com emacdonald@wfw.com www.wfw.com @WFW_LLP