Last edited 03 Feb 2017

Liquidated damages in construction contracts

Contracts generally include a provision for the contractor to pay liquidated damages (or liquidated and ascertained damages, sometimes referred to as LAD's) 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 (ie completing the works so they can handover the site to the client) by the completion date set out in the contract.

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. There may be a more complicated formulae where the works are phased, or where there will be partial possession. It is important that the method of calculation is 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. This would require them to prove that an actual loss had been incurred and that loss was not too 'remote'.

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). Under these circumstances, the client would still be able to pursue a claim for breach of contract.

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 (ie the completion date in the contract is adjusted), and the contractor may be able to make a claim for loss and expense. A relevant event might be a delay that is caused by the client, or a neutral event such as exceptionally adverse weather.

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.

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.

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.