Liquidated damages in construction contracts

[edit] Introduction

Contracts generally include a clause making provision for the contractor to pay liquidated damages (LD, sometimes referred to as liquidated and ascertained damages - LADs) to the client in the event that the contract is breached. In building contracts, liquidated damages usually relate to the contractor failing to achieve practical completion (i.e. completing the works so they can handover the site to the client) by the completion date set out in the contract. They are often calculated on a daily or weekly rate.

Liquidated damages are not penalties, they are pre-determined damages set at the time that a contract is entered into, based on a calculation of the actual loss the client is likely to incur if the contractor fails to meet the completion date. They might include; rent on temporary accommodation, removal costs, extra running costs, and so on. They are generally set as a fixed daily or weekly sum, although there may be a more complicated formulae where the works are phased, where may be partial possession and so on. It is important that the method of calculation is precisely and formally documented.

If the contract prevents the client claiming liquidated damages, or if actual losses are significantly different to those that were estimated at the time the contract was entered into, then the client may pursue a claim for unliquidated (i.e. actual) damages through the courts. Unliquidated damages are damages, the exact amount of which has not been pre-agreed, and are typically determined by the courts.

For more information, see Unliquidated damages.

As liquidated damages are not a penalty, they must have been based on a genuine calculation of damages when they were set. If they are not genuine, they may be considered a penalty by the courts and so will be unenforceable (see Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd), although this is unlikely as the courts are very reluctant to interfere in contractual agreements negotiated freely by two commercial parties of similar standing.

Calculations might include, amongst other things:

Loss of rent
Loss of income
Fees
Storage costs.
Rental costs.
Fees and fines imposed by third parties.
Finance costs.

There be a causal link between all the losses the contract foresees are likely to be suffered, and the breach of contract, i.e. the damages flow naturally from the delay and must not be 'remote'. The principle of 'remoteness' is established in the case of Hadley v Baxendale in 1854.

Liquidated damages can be beneficial for the client, as the remove their obligation to prove actual losses in the event of delay occurring. They can also be beneficial to the contractor as they limit their liability to a known amount in the event of delay.

However, in some circumstances, the parties to the contract will wish to exclude liquidated damages. In this case, they should not simply insert 'nil' as the rate of liquidated damages, as this can imply that the loss for unliquidated damages is also nil. Instead, they should make clear that unliquidated damages apply, or delete the clause for liquidated damages.

[edit] Extension of time

If the project is delayed by an event that impacts on the completion date, but is not the fault of the contractor, then this may constitute a 'relevant event' for which the contractor may be granted an extension of time (i.e. the completion date in the contract is adjusted). This can have the effect of relieving the contractor from a claim of liquidated damages.

However, mechanisms allowing extensions of time are not simply for the contractor's benefit. If there was no such mechanism and a delay occurred which was not the contractor’s fault, then the contractor could no longer be required to complete the works by the completion date and would only have to complete the works in a 'reasonable' time. With no enforceable completion date, the client would lose any ability to claim liquidated damages for other delays that are the contractor's fault.

It is very important when deducting liquidated damages to ensure that the correct contractual procedures are adhered to. In the case of Octoesse LLP v Trak Special Projects Ltd [2016], Justice Jefford held that Octoesse was not entitled to deduct liquidated damages as they had agreed to an extension of time after a certificate of non completion had been issued. The JCT Intermediate Building Contract is constructed such that:

'If the Contractor fails to complete the Works or a Section by the relevant Completion Date, the Architect/Contract administrator shall issue a certificate to that effect. If an extension of time is made after the issue of such certificate, the extension shall cancel that certificate and the Architect/Contract Administrator shall where necessary issue a further certificate.'

As Octoesse had not issued a further certificate of non completion, they were not entitled to deduct liquidated damages.

For more information, see Octoesse LLP v Trak Special Projects Ltd.

[edit] Partial possession and sectional completion

As construction nears completion, there can be considerable pressure to allow the client or tenants to take possession of part of a building or site, even if the works as a whole are ongoing or there are defects that have not been rectified. This can be pre-programmed as part of the works through a contractual requirement for sectional completion, but in the absence of such a provision many contracts offer the more open-ended option of partial possession.

Typically, the effect of partial possession or sectional completion of part of the works is to certify that those parts have achieved practical completion, and so to relieve the contractor of liability for liquidated damages for those parts.

In the case of sectional completion, it is important that separate completion dates and liquidated damages are set out in the contract for each section.

There can be complexities here however, where the ability of the contractor to complete one section on time is dependent on the previous section having been completed on time (the cascade effect). In this case the contractor will be liable for liquidated damages on each delayed section.

[edit] Early use

Early use can permit the client to make use of parts of the works that are not complete. In this case, the contractor may still be liable to pay liquidated damages in the event of late completion.

NB: On construction management projects, trade contracts (such as the Joint Contracts Tribunal (JCT) CM/TC 2011) may not include provisions for liquidated damages, instead the trade contractor indemnifies the client's direct loss and/or expense for lateness.

[edit] Related articles on Designing Buildings Wiki

[edit] External references

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Comments

In case of sectional completion or intermediate milestone - for example, if the last part of the project is not completed on time and the LD is to be applied - say maximum in the contract 10%.

The question is:

10% x remaining work amount

or

10% of the contract price.

It really depends what it says in the contract - see our article on Sectional Completion.