If you are reading the words ‘liquidated damages’ in your construction contract, then you might not be having the best day. You might be reading 1) an operative liquidated damages clause in your contract, or 2) a reference to a liquidated damages clause in another contract. Either way, it could be a problem for you.
The distinction between these two ‘types’ of liquidated damages has a huge impact on how easy it is to claim money for delay, and the financial outcome for your business if your work is delayed.
This newsletter explains what liquidated damages are, how they differ from unliquidated damages, how to tell the difference between the types of liquidated damages, and practical points to consider whenever you see the words liquidated damages.
What are liquidated damages?
Where one party is in breach of contract, the other ‘innocent’ party is entitled to damages. Liquidated damages are the amount which the parties agree will be payable as damages if a particular breach of the contract occurs.
In construction contracts, liquidated damages are often used for delayed completion and will be a rate that applies per day or per week. Another example of liquidated damages that might apply is a deduction for failure to achieve a certain gross internal floor area.
The current attitude of the courts is that parties should be free to agree to liquidated damages as doing so provides certainty about the consequences of a breach and avoids arguments about the level of loss actually suffered and whether it is recoverable.
What are unliquidated damages?
Unliquidated damages are simply the damages to be paid where there is no liquidated damages clause. They are usually valued as the amount of money to put the innocent party in the same position they would have been in if the contract had been performed (i.e. as if the breach had not happened).
Unliquidated damages can include many different types of losses, such as loss of rent, additional rent, additional preliminaries and staff costs, loss of production, loss of profits, and liquidated damages which the innocent party has to pay out (for example, the liquidated damages which a contractor has to pay the employer would be part of its claim for unliquidated damages against a sub-contractor which had caused delay).
Crucially, the party claiming unliquidated damages must prove that they were caused by the other party’s delay.
How are liquidated damages different from unliquidated damages?
The key differences where there is an operative liquidated clause rather than just a reference to liquidated damages in another contract are that:
- The claiming party does not have to prove that it suffered any actual loss: as the purpose of a liquidated damages clause is that the parties can agree what the outcome of the specified breach will be, the party relying on a liquidated damages clause does not have to provide any evidence of its costs or losses (or that it suffered any loss at all).
- The claiming party does not have to prove that any loss was caused by the other party: all the party relying on the liquidated damages clause has to do is demonstrate that there was a breach and the extent of it e.g. when the contractual date for completion passed and when practical completion actually occurred.
- The claim is likely to be limited to the rate of liquidated damages: liquidated damages are usually an ‘exhaustive remedy’ i.e. they are deemed to include all of a party’s losses for that breach. This means that where there is an operative liquidated damages clause in a sub-contract, the contractor is unlikely to be able to claim its delay-related additional preliminaries and costs from other sub-contractors on top of the liquidated damages rate.
This all means that in a typical sub-contract where there is a reference to the liquidated damages rate in the main contract, the main contractor claiming unliquidated damages from the sub-contractor (which, confusingly, includes any liquidated damages it is liable to the employer for!) is likely to have to prove that the employer has actually deducted liquidated damages and that the deduction in question (or part of it) was actually caused by the sub-contractor.
Where there is instead an operative liquidated damages clause in the sub-contract, the contractor just has to show that the relevant date has been missed and can then claim liquidated damages at the relevant rate, without needing to prove anything else.
How to tell the difference between an operative liquidated damages clause and a reference to liquidated damages in another contract
An operative liquidated damages clause must make it clear that if there is delay, then the specified rate will apply.
A reference to liquidated damages in another contract should be just that. For example, the JCT sub-contracts usually set out the main contract particulars which should state the rate of any liquidated damages in the associated main contract.
An issue that we sometimes see is that sub-contract particulars will refer to a liquidated rate (or multiple rates), but it is not until you look at the accompanying terms and conditions that it becomes clear whether the particulars are just referring to the rate in the main contract, or setting out a rate that applies where there is delay to the sub-contract.
What is the point of including a reference to liquidated damages in another contract?
The point of including a reference to liquidated damages in another contract is so that the party that commits the breach cannot argue that the level of damages is not recoverable because it was too ‘remote’.
In other words, where a sub-contract states that in the main contract there are liquidated damages of £1m per week of delay to the completion date, the sub-contractor cannot argue that those damages were not a likely result of delay to that date.
Where does extension of time fit in?
An extension of time is a defence to a claim for delay damages because where the time to complete all of the work or a section of it is extended, then there is no breach of contract where the relevant work is completed within the extended period.
That means it is very important that the contractual provisions regarding extension of time are followed strictly. This will often involve sending delay notices a short time after delaying events occur.
While parties are often reluctant to issue delay notices as they do not want to be accused of being overly ‘contractual’, by following the processes in the contract you are simply doing what the other party has agreed that you should be doing.
Practical points to protect yourself
- Before signing your contract, understand the references to liquidated damages. Is there:
- 1) an operative liquidated damages clause; or
- 2) a reference to liquidated damages in another contract?
- If there is an operative liquidated damages clause:
- Will you agree to that at all, or should you have the clause deleted?
- Is the rate for the overall completion date or are there different rates for different sections? If there are different sections and rates, do multiple rates apply at once where more than one section is delayed?
- Is the rate reasonable?
- How generous is the programme? The more generous the completion date, the less likely you are to incur liquidated damages.
- How likely is it that the programmed dates will be missed?
- Is the extension of time clause reasonable? If the extension of time clause requires notice in a very short period and only allows extension of time for very few potential events, or even ties the entitlement to whatever is received elsewhere in the contractual chain, then it is more likely that liquidated damages will be deducted than it would be if one of the unamended standard form contracts was used.
- Can you negotiate a cap on your liability for delay damages? If you negotiate a cap, ensure that you analyse the wording very carefully. Is your cap on the claim for liquidated damages only, or other claims as well?
- Once you are carrying out the work, follow the extension of time procedures in your contract.
How can CCC help?
CCC have decades of experience assisting parties in resolving disputes and all manner of construction issues, including:
- Contract reviews
- Liquidated damages clauses
- Delay claims
- Extension of time notices
- Extension of time claims
- Adjudication and Arbitration
