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Liquidated Damages – What are They, and How do They Work?

This article takes the JCT form of contract as its starting point for a look at the ways in which liquidated damages operate in construction.

Liquidated damages are a well established method to collect compensation for a specific breach of a contractual obligation. Rather than fighting over unspecified damages, parties will agree a set figure. This allows the injured party to apply a pre-determined amount in the case of, for example, late completion of a project.

If the client intends to deduct liquidated damages, they must have agreed the amount payable in the contract particulars. Should the contract not detail the amount payable, the client would have to rely on unliquidated damages. In that case, the actual losses incurred must be substantiated.

Liquidated damages are deducted from the amount payable (or repaid by the contractor). They arise when the completion of the works extends past the date specified in the contract. If any extension of time has been granted, liquidated damages will only apply to delay beyond the amended completion date. Depending on the wording of the contract, the liquidated damages apply to either a section of the works or the entire works.

As outlined above, liquidated damages need to exist in the contract.  The client can make a claim for them when the Architect/Contract Administrator has issued a non-completion certificate for either the works or the section. The client must also notify the contractor that they intend to deduct liquidated damages. This must (under JCT) happen no later than 5 days before the final date for payment of the final certificate (clause 2.32.1).

Options…

Following this process leads to an adjustment of the final payment to take into account damages at the agreed rate. The client then has two options. The first is to issue a notice requiring the contractor to pay the liquidated damages. This option is typically used if the contractor has already been paid more than the adjusted final account and is in debt. The other option is to deduct the liquidated damages from the final payment made to the contractor. In both options, the client may claim for a smaller amount of money than is stated in the contract. However, they cannot claim for a higher amount (clause 2.32.2).

The completion date may be later extended by the Architect/Contract Administrator. In that case, the client must repay any liquidated damages, up to the amended completion date (clause 2.32.3). The only other mechanism which allows the contractor to reclaim liquidated damages is in the event of cancellation of the non-completion certificate. In that case all money deducted by the client must be repaid (clause 2.32.4).

What if the contractor is late?

However, even if the contractor has failed to complete the works on time, the damages agreed in the contract may not be enforceable. For example, if the amount is unreasonable. This happened in Dunlop Pneumatic Tyre Ltd v New Garage & Motor Co Ltd [1915]. The courts ruled that the liquidated damages in the contract did not reflect a genuine pre-estimate of the loss caused by the breach. This meant they were a penalty rather than compensation.

The client must be able to justify that the liquidated damages were a reasonable assessment of loss (at the time of signing the contract). To not do so risks a legal battle with the contractor. Should the courts rule in favour of the contractor, the client would have to rely on unliquidated damages. As noted above, these must be evidenced and may not reflect the true loss incurred.

Recent Changes and NIL Entries

It is also worth looking at the case of Cavendish v Makdessi; ParkingEye v Beavis [2015] UKSC 67, in which the court adjusted the rules for damages slightly. In this case, the court decided a party can, in some circumstances, enforce performance beyond compensation for loss.

Finally, a note about contracts in which the amount for damages is noted as £NIL or Zero. This is sometimes done, when parties do not wish Liquidated Damages to apply. However, it should be noted that simply entering NIL or Zero into a standard form contract may not have the effect you intend. This helpful article from the solicitors at CMS gives some more advice: https://www.cms-lawnow.com/ealerts/2008/10/liquidated-damages-na?sc_lang=en

Conclusion

As can be seen, the process for establishing and claiming damages is not necessarily simple. However, LD’s provide a useful mechanism for recovering loss and encouraging timely project completion. There have been several recent cases relating to other aspects of damages. See this article by White & Case for more detail. And should you need any more assistance with any of the issues in this article, get in touch today.