Delay and Disruption - Types of Liquidated Damages Clauses© Daniel Atkinson 2006 1 July 2006PRACTICE NOTE
Liquidated Damages (LD) Clauses are limited to clauses which create
contractual obligations and to breach of those obligations, otherwise they
are simply clauses which apportion risk or determine the measure of payment.
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Breaches & Risk Events |
Failure to Complete |
Failure to Pay |
Performance Criteria Failure |
Express Terms Standard Forms |
FIDIC 1999 |
ICE 7 Ed |
NEC3 |
MF/1 Rev 4 |
IChemE 4th Ed |
JCT 2005 |
If the clause does not create a contractual duty then it simply operates to allocate risk and/or determine the measure of payment and strictly such a clause is not a liquidated damages clauses - the principles of penalties do not apply.
The House of Lords in Export Credits Guarantee Department v Universal Oil Products Company [1983] 23BLR111 agreed with the Court of Appeal that the clause in question was not a penalty clause because it provided for payment upon the happening of a specified event other than a breach of contract. The law regarding penalty clauses had not been extended beyond clauses creating contractual duties:
"… one purpose, perhaps the main purpose, of the law relating to penalty clauses is to prevent a plaintiff recovering a sum of money in respect of a breach of contract committed by the defendant which bears little or no relationship to the loss actually suffered by the plaintiff as a result of the breach by the defendant. But it is not and never has been for the courts to relieve a party from the consequences of what may in the event prove to be an onerous or possibly even a commercially imprudent bargain.”
Conceptually an LD clause could apply to any type of breach of contract, either a single event or a continuing breach.
It was argued in Jeancharm Limited v Barnet Football Club Limited [2003] EWCA Civ 58 that the law had moved on since Dunlop Pneumatic Tyre Co Ltd -v- New Garage and Motor Co Ltd (1914) so that one should look at the contract as a whole, look at the risks being undertaken by both sides and ask whether the clause was an appropriate clause, having regard to the risk undertaken by the opposite party.
Mr Justice Jacob in the Court of Appeal held that nothing in the judgment of the judicial committee of the Privy Council in Philips v The Attorney General of Hong Kong [1993] 61 BLR 41 suggested a departure of the gigantic nature suggested from the law as laid down by Lord Dunedin in Dunlop. Lord Dunedin indicated that the question of whether or not a clause was a penalty clause depended upon whether it could be regarded as a genuine pre-estimate of the damage caused if there was a breach. The Court held that the suggested formulation abandoned that entirely.
Failure to complete by a specified date is the most common breach of contract for which LD clauses are used in the construction industry. The damages are usually expressed in Standard Forms as an amount per day or per week of delay to completion to be paid by the Contractor to the Purchaser.
In some commercial developments there may be a critical delay beyond which the damages change – such as a critical date for supply or opening a development. In such cases a limit is usually stated for the overall amount of LDs or another rate is stated to apply after the critical date. It may be necessary in specific situations to stipulate a maximum delay beyond which the LD provision is no longer an adequate remedy and the contractor’s performance is considered and agreed as no performance at all.
If sections of the works have different importance to the Purchaser, sectional completion dates should be stated with different LD rates together with a rate for the remainder of the works.. Standard Forms usually allow the Purchaser the flexibility to take over parts of the works. The entitlement to LDs should be modified in that case to reflect the reduced damages for any delay caused by the contractor, so that the right to LDs for the remainder of the works is not lost.
Failure to pay by a certain date is a breach of contract not usually associated with liquidated damages clauses, but such a clause could provide for payment of interest at an increased rate for the period of delay.
Mr Justice Jacob in the Court of Appeal in Jeancharm Limited v Barnet Football Club Limited [2003] EWCA Civ 58 considered that one can have an increased rate of interest as a valid clause in some circumstances and referred to the decision of Colman J in Lordvale Finance plc v Bank of Zambia [1996] QB 752. In that case there was an uplift of 1% for late payment of a debt. That was held to be a genuine pre-estimate on the basis that it indicated that the borrower was a risky borrower. Mr Justice Jacob observed that there was nothing in the decision which suggests that anything other than what Colman J called a "modest increase" would do.
Failure to provide a plant which gives the required throughput is the breach of contract for which LD clauses are used in contracts for industrial and/or mechanical plant. A measurable performance target is required. It may be necessary to stipulate a minimum level of performance required. If performance falls below this level the Plant may be considered and agreed no longer to be a viable plant, the LD provision no longer an adequate remedy and the contractor’s performance not to be performance at all.
In order to establish the threshold for levy of liquidated damages the required performance needs to be prescribed by measurable parameters. It is necessary to specify the duration of the tests, performance criteria and method of assessment by reference to standards together with tolerances. It may be necessary to specify correction factors if the operating conditions required for the tests cannot be created.
The specified performance may include plant throughput, energy or feedstock useage, quality of product and extent of waste or byproduct. These performance criteria may be inter-related, so that some criteria should be grouped if a realistic measure of the benefit to the Purchaser is to be measured.
The Standard Forms of contract do not adopt the same approach to liquidated damages for delay. Some forms make the liquidated damages clauses part of the contract with no discretion, but provide an option for section liquidated damages. In that case it is important to ensure that a rate is entered for liquidated damages. Only ICE 7th Edition addresses the consequences of an entry of “nil” or the rate left blank. Some forms make liquidated damages an option. Not all the forms allow the insertion of a limit on liquidated damages and only MF/1 Rev 4 properly addresses the consequences of a maximum period of delay being exceeded.
As expected only those forms used in processing or M/E projects include liquidated damages for plant performance. The MF/1 Form adopts a well considered approach. Many of the forms recognise that the failure to achieve a minimum level of performance may make the Plant of little commercial value.
Clause 8.7 Red, Yellow and Silver provides for delay damages for the Contractor’s failure to comply with Clause 8.2 which requires the Contractor to complete the whole of the Works and each Section within the Time for Completion for the Works or Section. There does not appear to be provision for stating delay damages for each Section.
The rate of delay damages is stated in the Appendix (Red and Yellow) or the Particular Conditions (Silver) as a rate per day of delay and there is provision for stating a maximum amount of delay damages. The Appendix (Red and Yellow) requires a percentage of the Accepted Contract Amount to be stated for both the delay damages and the limit. Clause 14.15(b) (Red and Yellow) provides that the payment of damages are to be made in the currencies and proportions stated in the Appendix to Tender, which states that the proportions are those in which the Contract Price is payable.
Clause 8.2 Red, Yellow and Silver expressly states that the delay damages are the only damages due from the Contractor for default under Clause 8.2 except in the event of termination under Clause 15.2.
The mechanism of liquidated damages is built into the form and the Appendix or Particular Conditions are therefore required to be completed and must not be left blank. The Employer’s right in relation to delay damages is subject to Clause 2.5 (Red and Yellow) which specifies the notice of claim required to be provided by the Employer.
The FIDIC Forms Red, Yellow and Silver do not provide for performance related liquidated damages, but at Clause 9.4(b) provides that if a Works or section fails to pass the Tests on Completion and if the failure deprives the Employer of substantially the whole benefit of the Works or Section, then the Employer can reject the Works or Section and terminate the Contract as a whole or in respect of the major part which cannot be put to intended use. The Employer is then entitled to recover all sums paid for the Works or such part plus financing costs, the costs of dismantling, clearing the Site and returning Plant and Materials to the Contractor, without prejudice to the Employer’s other rights.
Clause 47(1) provides for liquidated damages where the whole of the Works is not divided into Sections. The Clause requires a sum to be stated in the Appendix to the Form of Tender. The Employer has no discretion - liquidated damages are built into the ICE 7th form.
Clause 47(4)(b) states that if no sum is stated in the Appendix or a sum of “nil” is inserted then “to that extent damages are not payable”. It is suggested on an interpretation of the Contract as a whole that this does not mean that the LD provisions do not apply but that the level of LDs is nil.
Clause 47(1) states that the sum stated represents the Employer`s genuine pre-estimate of the damages likely to be suffered if the whole of the Works is delayed. This is required to be expressed as a sum per week or per day. The sum is required to be the genuine pre-estimate, not a lesser sum. Clause 47(2) repeats the provisions in Clause 47(1), but for sectional completion.
Clause 47(4)(a) provides that a limit may be stated in the Appendix, but if not then liquidated damages without limit shall apply.
ICE 7th Edition now makes clear that it is the Contractor’s failure to achieve “substantial completion” within the time prescribed which triggers the entitlement to liquidated damages and not failure to complete as it was under ICE 6th Edition.
Clause 47(5) entitles the Employer to deduct LD`s or requires the Contractor to pay LD`s when they become due and the amounts become due by virtue of Clauses 47(1)(b) or 47(2)(b). The Employer is required to repay that proportion of LD`s already deducted, which are no longer due following an extension of time or further extension of time. The Clause also requires the Employer to pay interest at the rate in Clause 60(7). ICE 7th Edition now requires the interest to be compounded monthly.
Clause 47(6) provides for the effect of certain events which arise after liquidated damages become payable, that is when a contractor is in a period of culpable delay. The events are:
Clause 47(6)(b) provides that if the Engineer is of the opinion that these will result in further delay to that part of the Works, then the Employer’s further entitlement to liquidated damages is suspended until the Engineer notifies that the further delay has come to an end. It is now clear in ICE 7th Edition that any liquidated damages already deducted or paid can be retained by the Employer, but subject to any subsequent or final review of the circumstances causing delay. It is suggested that it is intended that if an extension of time is granted for the events then the value of the liquidated damages due will be affected.
The Clause does not deal with the inter-relation between the suspension of liquidated damages and the extension of time provisions. The term “any other situation outside the Contractor’s control” is not one of the events listed in Clause 44 entitling a contractor to an extension of time. It would appear therefore that the extension of time entitlement and the suspension of liquidated damages are separate and cumulative entitlements. It is not clear whether the liquidated damages are simply no longer operated or postponed until either notification by the Engineer under Clause 47(6)(b) or final review of the circumstances causing delay.
Option X7 provides for delay damages at the rate stated in the Contract Data from the Completion Date to the earlier of Completion or the date when the Employer takes over the works. The Contract Data Part One provided by the Employer specifies delay damages per day. Option X7 requires the Contractor to pay the delay damages.
Clause 50.2 provides that the amount due (at each assessment date) is to be reduced by the amount to be paid by the Contractor.
Option X7 also provides that if the Completion Date is changed to a later date after delay damages have been paid, then the Employer repays the overpayment of damages with interest. The date of repayment is stated to be an assessment date. Clause 51.4 provides that interest is calculated on a daily basis at the interest rate and is compounded annually.
Option X7 also provides for adjustment of the delay damages if part of the works is taken over by the Employer before Completion, based on a proportion of the benefit to the Employer assessed by the Project Manager.
Option X5 provides for section of the works and Contract Data Part One allows the section to be described, the completion date for each section to be specified and the amount of delay damages for each section to be specified.
There appears to be no provision in NEC3 to limit the overall amount of delay damages. Option X18 specifies various limits on liability, but excluded matters which include delay damages.
Option X17 provides for low performance damages as stated in the Contract Data. The Contract Data Part One provided by the Employer specifies the amount of low performance damages for each specified performance level. Option X17 requires the Contractor to pay the low performance damages. Clause 50.2 provides that the amount due (at each assessment date) is to be reduced by the amount to be paid by the Contractor.
Clause 2.32 allows the Employer to withhold or deduct liquidated damages or to require the Contractor to pay liquidated damages at the rate stated in the Contract Particulars. The Contract Particulars requires a rate and the period for the rate to be inserted.
The sixth recital (if not deleted) states that the division of the Works into Sections is shown in the Contract Bills and/or the Contract Drawings or in such other documents as are identified in the Contract Particulars. The Contract Particulars allows the Dates for Completion of Sections to be specified together with the rate of liquidated damages for each Section.
Clause 2.32.3 provides that if a later Completion Date is fixed or stated then the Employer pays or repays to the Contractor any amounts recovered, allowed or paid under clause 2.32 for the period up to that later Completion Date. There appears to be no provision for payment of interest, although Clause 4.23 allows recovery of loss and expense. If the events which entitle a revised Completion Date are Relevant Matters under Clause 4.24 then it could be argued that the loss of interest on the monies paid or withheld as liquidated damages are recoverable. The difficulty however is establishing causation.
Clause 2.33 allows the Employer early possession of parts of the Works with the consent of the Contractor and Clause 2.37 provides for the rate of liquidated damages stated in the Contract Particulars to be reduced from the Relevant Date, by the same proportion as the value of the Relevant Part bears to the Contract Sum. The assumption therefore is that the measure of loss for delay of a part is proportional to the construction value of the part measured by the Contract Sum. This is unlikely to be correct unless the loss is related directly and only to the financing of the project.
There appears to be no provision in JCT 2005 to limit the overall amount of delay damages.
Clauses 32 and 33 deal with the Time for Completion, extension of time and delay and do not provide for sectional completion. There are Additional Special Conditions for use where the Contract is to provide sectional completion and damages for delay in completion of sections by replacing Clauses 33.1, 33.2 and 34.1.
Clauses 34.1 and 34.2 deal with liquidated damages. Clause 34.1 states that if the Contractor fails to complete the Works in accordance with the Contract within the Time for Completion, or if no time is fixed within a reasonable time, then the percentage stated in the Appendix of the Contract Value is to be deducted from the Contract Price or paid to the Purchaser by the Contractor. The percentage only applies to those parts of the Works which cannot be put to use intended as a consequence of the failure to complete. This is an unusual provision. It is necessary because the LDs are expressed as a percentage, in this case a percentage of the Contract Value which is defined as the part of the Contract Price properly apportionable to the Plant or work in question. It is necessary therefore to both identify and value the part of the Works not put to the use intended before the amount of LDs can be determined. The deduction/payment is stated to be for each week of delay and this is repeated in the Appendix.
It is unusual in any model form for the provision of completion to be within a reasonable time. It is normal that the time for completion to be fixed.
The Special Conditions Clause 34.1 is in similar terms as the standard clause but with reference to sections as well as the Works. Clause 34.1 provides that the amount of deduction/payment shall not exceed the maximum percentage stated in the Appendix. The deduction/payment is stated to be in full satisfaction of the Contractor’s liability for the failure to complete, subject to Clause 34.2.
There are therefore two delay damages regimes in the Contract. The first is a liquidated damages regime which applies up to a limit, but if that is exceeded then Clause 34.2 applies. It is suggested that on a proper interpretation of the Contract that the remedies under Clause 34.1 and 34.2 are not mutually exclusive. The rights under Clause 34.2 are additional to LDs under Clause 34.1.
Clause 34.2 relates to prolonged delay and allows the Purchaser by notice to require the Contractor to complete and to fix a final Time for Completion where the Contractor has been so delayed as to incur the maximum amount provided under Clause 34.1. Further the Purchaser may decide to terminate the Contract in respect of that part of the Works and recover from the Contractor any loss suffered by the Purchaser by reason of the said failure up to an amount not exceeding the sum stated in the Appendix, or if no sum is stated, that part of the Contract Price that is properly proportional to such part of the Works as cannot by reason of the Contractor’s failure be put to the use intended.
The combination of liquidated damages and unliquidated damages for late completion is an unusual feature of MF/1. The approach does properly deal with the situation where the delay is so great that it is not commercially practical to estimate the loss using the LD mechanism.
Clause 35.8(a) provides that if the Works or any Section fails to pass the Performance Tests within the period specified in the Special Conditions, or if no period is specified within a reasonable time, the Contractor pays or allows liquidated damages if they are specified in the Special Conditions for failure to achieve guaranteed performance. On payment/deduction the Purchaser accepts the Works.
The Clause 35.8(a) provision only applies if the results are within the stipulated acceptance limits. If not then Clause 35.8(b) applies instead. Clause 35.8(b) also applies if liquidated damages have not been specified for failure to achieve guaranteed performance. Clause 38.8(b) provides that the Purchaser can accept the Works with a reasonable reduction of the Contract Price. The Purchaser has an alternative remedy under Clause 35.8(d) if the failure to pass the Performance Tests is such as to deprive the Purchaser of substantially the whole benefit of the Works or Section. In that case the Purchaser is entitled to reject the Works or Section and proceed under Clause 49 which relates to termination of the Contract for Contractor’s default.
Clause 15.1 states that if the Contract provides for payment of liquidated damages for delay, then the Contractor is to pay or allow the Purchaser LD’s at the rate prescribed in Schedule 9 for failure to complete the Works or any specified section or stage in Schedule 5. Clause 15.1 provides that the Contractor has no liability to pay LD’s in excess of the maximum (if any) stated in Schedule 9.
The IChemE Red Book is drafted so that the detail of the LD provisions is in Schedules 5 and 9. If LD’s for delay do not apply then it is prudent to expressly so state in Schedule 9 or the Special Conditions. Schedule 5 is required to state the times and stages of completion and Schedule 9 should state the rates for LD’s. The main event in Schedule 5 for the purpose of Clause 15 is likely to be completion of construction under Clause 33. However Take Over under Clause 34 may be the event if full production is the more relevant benefit.
Clause 35.10 provides that if the Plant does not pass any performance test within 90 days of the date of the relevant Take-Over Certificate, the Contractor pays liquidated damages to the Purchaser in accordance with Schedule 10. If the results of any performance tests are outside any limits specified in Schedule 10, then instead of liquidated damages, the Purchaser may either accept the Plant with a reasonable reduction in the Contract Price or reject the Plant in accordance with Clause 41.
Clause 35.2 states that the performance tests to be carried out are those specified in Schedule 7. Schedules 7 and 10 are inter-related and need to be carefully drafted by the Purchaser. The threshold for performance needs to be easily established by reference to Schedule 7. The level of liquidated damages for ranges of low performance needs to be specified in Schedule 10, by reference to the tests in Schedule 7, and a limit specified beyond which the liquidated damages are no longer the contractual remedy for the breach of contract.