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03 Mar 2017

Liquidated damages – another look

We have a mixed-use development which is being constructed under a JCT Design and Build Contract. We were advised to provide for sectional completion.

The works were completed late and we are entitled to deduct liquidated damages. However, the contractor is arguing that as two of the retail units have not been let, we have suffered no loss in relation to these, and the liquidated damages for these sections, which were based on the expected rents, are penalties and unenforceable. Is this correct? If it is, are we entitled to recover other losses that we have suffered as a result of the delayed completion of these units?

English law generally does not allow “penalties” in contracts, so to this extent the contractor is correct. However, liquidated damages are permissible provided that they do not amount to a penalty. The distinction between an unenforceable penalty and an enforceable rate of liquidated damages essentially boils down to whether the rate of liquidated damages represents a genuine pre-estimate of the damages that the employer will suffer if the works are delayed. This principle was established by the 1915 case of Dunlop Pneumatic Tyre Company Ltd. V New Garage and Motor Company Ltd.

Case law has moved on since 1915 in a way which is favourable to the employer: the modern approach is that commercially experienced parties should be free to agree on the appropriate rate of liquidated damages and, in general, the courts will uphold liquidated damages wherever possible. For example, in Alfred McAlpine Capital Projects Ltd v Tilebox Ltd, a 2005 decision, a liquidated damages rate which included an allowance for a potential liability to a third party was held to be enforceable even if there was no such liability. It’s clear that the “genuine pre-estimate” of the damages that would be caused by delay can be reasonable, even if it’s not right.

Reference to loss

Liquidated damages rates are frequently set by reference to loss of rent and this is a perfectly reasonable and valid approach to calculating the “genuine pre-estimate”. The fact that this approach can, as in your case, produce a figure which exceeds the actual loss does not prevent it from being enforceable.

Although it is not relevant in your case, in the rare case where liquidated damages are held to be a penalty, the employer will generally be able to recover the actual losses that it can prove were caused by the delay in completion.

However, the entries in the “Contract Particulars” of a JCT Contract in respect of liquidated damages do have to be filled in very carefully. For example, a developer who inserted “nil” as the rate, on the basis that he wanted to rely on general damages for delay, was shocked to discover that he could not do so. In this case, the rate of liquidated damages (nil) was clearly not a penalty, so the liquidated damages clause was enforceable. An enforceable liquidated damages clause in a JCT Contract will be treated as the only available remedy for delay. So, insertion of the word “nil” effectively meant that employer had no redress in respect of the contractor’s delay.

This article originally appeared in Professional Housebuilder and Developer.