1. Commercial and legal aspects of
liquidated damages and penalties
W.K.Amila Gayan
B.Sc. (Hons.) in QS, LLM (Cons.Law & Arbi.), FCIArb., MRICS,AIQS(SL)
Commercial Manager - AlTurki Enterprises LLC
Chartered Quantity Surveyor/Board Member of RICS MENA
Construction & QS Working Group/ RICS and IQSSL APC
Counsellor/Supervisor
Presented in a CPD organised by Australian Institute of Quantity Surveyors –Oman Branch on 15 June 2015 at Al Maha International
Hotel, Oman
Disclaimer
The information contained in this presentation is for education purposes only and should not
be considered as legal advice. The information presented should not be acted upon without
professional advice.
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2. Contents
Introduction
General damages v Liquidated Damages (LDs)
LDs v Penalties
Calculation of LDs
Advantages of LDs
LDs in standard forms of contract
LDs in GCC countries
Case study
Conclusion
Q& A
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3. Introduction
Contracts bind the parties of the contract to its terms.
If one party breaches the terms of contract, the other
party may injure/incur losses.
Damages, equitable remedies and rescission are the
available redress mechanisms for breach of contracts.
A breach of contract would cause disputes.
It is wise to have provisions to deal with most likely
breaches in commercial contracts.
Liquidated Damages (LDs) or Liquidated Ascertained
Damages (LADs) provisions were introduced to contracts.
LDs are genuine pre-estimate of an anticipated loss.
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4. Introduction
Provision of LDs are now common in construction
contracts. Ex ;- Delay damages, interest on delayed
payment, reimbursement of overtime supervision cost
LDs are widely used to define delay damages i.e. losses
due to delay in completion of projects.
The legal principles applicable to LDs are substantially
differ in common law and civil law countries.
The validity of LD clauses and its enforceability will be
depended on such legal principles.
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5. General damages v LDs
The damages (general/unliquidated) are monetary sum fixed
by the courts in order to compensate the injured party for
any losses incurred as a result of a breach of contract .
Damages are not to punish defendant.
Generally punitive damages are not awarded for breach of
contract.
The purpose of awarding damages is to put the innocent
party back in to the position it would have been had the
contract been properly performed.
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6. General damages v LDs
Three important principles that has to be established to be successful in a
claim for damages ;
Causation – Loss must be caused by breach
Remoteness - Loss must be fairly and reasonably be considered as arising naturally
from breach or Contemplation of loss by parties at the time the contract was made
as a probable results of the breach
Mitigation – Took reasonable steps to mitigate the loss
LD clause in a contract stipulates a specific sum that is payable for particular
breach of term of contract.
The courts are reluctant to uphold challenges to LD clauses.
Freedom of contract/terms of the contract are said to be the law governing
the contract.
The whole purpose of LD clause; parties to a contract being able to agree
beforehand what damages are to be recoverable in the event of a breach of
contract. (Philips Hong Kong Ltd v AG Hong Kong, Privy Council Appeal No.29 of 1991 (1993) 61
BLR 41)
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7. LDs v Penalties
In English legal system and most of other common law
countries LD provision will be invalid if it proves to be a
penalty.
 Generally punitive damages are not available for breach of
contract.
 Lord Dunedin in Dunlop PneumaticTyre Co Ltd v New Garage
& Motor Co Ltd [1915] UKHL stated ;
The essence of penalty is payment of money stipulated as in terrorem
of the offending party; the essence of liquidated damages is a genuine
covenanted pre-estimate of damage.
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8. LDs v Penalties
 The judge in Jeancharm Limited v Barnet Football Club Limited
[2003] EWCA Civ 58 mentioned four important principles to
be considered to determine whether LD clause is a penalty;
1. the court looks at the substance of the matter, rather than the form
of words, to determine what was the real intention of the parties;
2. the essence of a penalty is a required payment in terrorem of the
party in default, as distinct from being a genuine pre-estimate of loss
resulting from the default;
3. the question whether a provision for payment on default is a penalty
is a question of construction of the contract, and that is assessed at
the time of the contract and not at the time of the breach;
4. if the required payment is extravagant and unconscionable in amount
in comparison with the greatest loss that could conceivably be
established as the consequence of a default, it is a penalty.
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9. Calculation of LDs
LDs are genuinely estimated amounts of potential loss arising out of
breach of contract.
Estimation of such amounts has to be carefully calculated which otherwise
LDs may consider as penalties.
 “It is recommended that calculations for liquidated damages are
thoroughly considered by the employer and the quantity surveyor/project
manager and a detailed record of the final value retained in case they are
challenged at a later date.(” RICS Guidance Notes in Damages for Delay to
Completion, 2011)
QSs will have a major role to play in LD calculations as a professional
involved in the pre-contract stage.
Even though calculation of LDs has to be done as accurate as possible, the
courts will not decide LDs as penalties if LD amount exceeds the actual
loss.
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10. Calculation of LDs
 In Alfred McAlpine Capital Projects Ltd vTilebox Ltd [2005]
BLR 271 (TCC), the judge stated;
a pre-estimate does not have to be right in order to be
reasonable.There must be a substantial discrepancy between
the level of damages stipulated in the contract and the level of
damages which is likely to be suffered before it can be said that
the agreed pre-estimate is unreasonable.
 Major elements to be considered in calculation of LDs;
1. Loss of revenue/return on the investment.
2. Supervisory cost.
3. Loss due to extending finance cost.
4. Other miscellaneous cost.
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11. Calculation of LDs
 Loss of revenue/return
 Hotels
 loss of revenue of rooms & other
facilities (restaurants, leisure facilities,
banquet halls etc)
 Occupancy levels based on seasons or
special occasions
 Running costs (utility consumption,
cleaning, laundry, employees cost etc) to
be deducted
 Office blocks/residential units
 To occupy-cost of leasing alternative
building/accommodation
 To lease – loss of revenue/rent
 Retail buildings
 Expected return/profit
 Revenue in seasonal periods
 LDs can be calculated for sections/milestones.
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12. Advantages of LDs
 Force the parties to not to breach contract terms
 Financial certainty of consequences of breach of
contract
 Accordingly risk can be allocated
 Limitation of liability
 Non-defaulting party can recover the loss without the
difficulty and expense of proving actual loss
 No legal costs since loss can be recovered under the
contract
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13. LDs in Standard Forms of Contract
FIDIC 99 Suit of Contracts (CONS, P & DB and EPCT)
 Clause 8.7 – Delay Damages
If the Contractor fails to comply with Sub-Clause 8.2 [Time for
Completion ], the Contractor shall subject to Sub-Clause 2.5 [
Employer’s Claims ] pay delay damages to the Employer for this default.
These delay damages shall be the sum stated in the Appendix to
Tender, which shall be paid for every day which shall elapse between
the relevantTime for Completion and the date stated in theTaking-
Over Certificate. However, the total amount due under this Sub-Clause
shall not exceed the maximum amount of delay damages (if any) stated
in the Appendix toTender.
These delay damages shall be the only damages due from the
Contractor for such default, other than in the event of termination
under Sub-Clause 15.2 [Termination by Employer ] prior to completion
of theWorks.These damages shall not relieve the Contractor from his
obligation to complete theWorks, or from any other duties, obligations
or responsibilities which he may have under the Contract.
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14. LDs in Standard Forms of Contract
FIDIC 99 Suit of Contracts (CONS)
 Employer shall submit Employer’s Claim as per Clause 2.5 for Delay
Damages.
 Engineer will then make a determination under Sub-Clause 3.5.
whether Employer is entitled to deduct an amount as delay damages.
 it can be deducted from Payment Certificates in accordance with
Clause 2.5.
 If aTaking-Over Certificate is issued for part of the works (Clause
10.2) , the delay damages are reduced for the remaining works, assuming
they are not delivered within the time for completion.
 The proportion of reduction is calculated based on a pro-rata of the
value of the works certified.This will not have any effect in reducing the
maximum liability for damages stated in the Appendix toTender.
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15. LDs in Standard Forms of Contract
Standard Documents for Building and Civil Engineering
Works 1981
 Clause 47.1 – Penalties for Delay
If the Contractor shall fail to achieve completion of theWorks within
the time prescribed by Clause 43 hereof, or such extended time as may
be allowed under Clause 44, hereof, then the Contractor shall pay to
the Employer the sum stated in the appendix to theTender as a penalty
for such default for every day or part of a day which shall elapse
between the time prescribed by Clause 43 hereof or the extended
time as the case may be and the date of certified completion of the
Works.The Employer may, without prejudice to any other method of
recovery, deduct the amount of such penalties from any monies in his
hands due or which may become due to the Contractor.The payment
or deduction of such penalties shall not relieve the Contractor from his
obligation to complete theWorks, or from any other of his obligations
and liabilities under the Contract.
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16. LDs in Standard Forms of Contract
 Clause 47.2 – Reduction of Penalties
If, before the completion of the whole of theWorks any part of section of the
Works has been certified by the Engineer as completed, pursuant to Clause 48
hereof, and occupied or used by the Employer, the penalties for delay shall, for
any period of delay after such certificate and in the absence of alternative
provision in the contract be reduced in the proportion which the value of the
part or section so certified bears to the value of the whole works.
Standard Documents for Building and Civil EngineeringWorks 1999
 Clause 47.1 – Penalties for Delay
If the Contractor shall fail to achieve completion of the Works within the time
prescribed by Clause 43 hereof, or such extended time as may be allowed
under Clause 44, hereof, then the Contractor shall pay to the Employer the
sum stated in the appendix to theTender as a penalty for such default for every
day or part of a day which shall elapse between the time prescribed by Clause
43 hereof or the extended time as the case may be and the date of certified
completion of the Works provided such sum does not exceed 10%.
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17. Few more important aspects of LDs
 If the amount in Appendix to the Form ofTender “Nil” for LDs?
The employer may lose the right to impose any damages for breach. (Temloc Ltd v Errill
PropertiesLtd [1987] 39BLR34 CA)
 If the amount in Appendix to the Form ofTender left blank for LDs?
The employer may lose the right to impose LDs for breach but may get general damages.
[Gilbert-Ash (Northern) Ltd v Modern Engineering (Bristol) Ltd [1974] AC689 HL]
 Can the employer impose LDs even if he has not incurred actual loss?
They employer may deduct LDs from contractor even there is no actual loss. [BFI Group of
Companies v DCB Integration Systems Ltd (1987)]
 Who has to prove LDs are penalties in a challenge for LDs?
The contractor will have to prove that LDs are penalties in a challenge to a LD provision in a
contract. (Philips Hong Kong v The Attorney General of Hong Kong (1193).
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18. LDs in GCC Countries
 Article 390 of the UAE Civil Code states that:
(1)The contracting parties may fix the amount
of compensation in advance by making a
provision therefore in the contract or in a
subsequent agreement, subject to the
provisions of the law.
(2)The judge may in all cases, upon the
application of either of the parties, vary such
agreement so as to make the compensation
equal to the loss, and any agreement to the
contrary shall be void.
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19. LDs in GCC Countries
 Dubai Court of Cassation judgment 138/94
 The case was about a dispute between contractor and
his subcontractor regarding delay in completion of
supply and installation of doors.
 Penalty clause for delay in completion
 Claimant sought full penalty
 Court exercised its right under Article 390 of civil code
to review penalty
 Actual loss was less than agreed damages
 Court awarded only actual loss suffered
 Penalty and LDs were considered equally and there
was no pure distinction drawn to difference between
the penalty and LDs
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20. LDs in GCC Countries
 Article 265 of the Qatar Civil Code states that:
If the object of an obligation is not a sum of money,
the contracting parties may determine in advance
the value of the compensation in the contract or
in a subsequent agreement.
 Article 266 of the Qatar Civil Code states that:
The agreed compensation will not be payable if
the debtor shows that the creditor has not
incurred a loss.The court may reduce the
compensation from what is agreed if the debtor
shows that the determination is grossly
excessive or that the obligation has been partially
fulfilled.Any agreement to the contrary will be
void.
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21. LDs in GCC Countries
 Article 267 of the Oman Civil Code states that:
(1) If the subject matter of obligation is not a sum of money,
the contracting parties may determine the amount of
compensation in advance by making a provision of the same in
the contract or in a subsequent agreement.
(2) In all cases, the court may, upon the application of either
of the parties, amend such agreement to make the
compensation equal to the damage, and any agreement to
the contrary shall be null and void.
 Experts argue that the basic purpose/advantage of LDs i.e. the
certainty or agreed pre-estimated amount, given by such clause is
diminished by court interference.
 At the same time others argue that such rules do the justice to
situations where there are no actual losses incurred and the defaulting
party is still liable to pay LDs.
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22. Case Study
 Contract was in bespoke contract conditions.
 Contract specified ;
Working Hours for Site
Contractor shall include for working normal Employer’s hours:-
07.00 to 16.00, 1 hour Lunch break, Saturday toWednesday inclusive
Should Contractor require to work outside these hours then prior arrangement must be
sought from Employer and no additional payment will be made.
 Contractor had worked outside the working hours specified
and the Employer claimed their Consultant’s supervisory charges
from the contractor.
 The recovery of consultant’s supervisory charges disputed by
the contractor. .
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23. Case Study
 A proper LD clause in such a scenario would have been;
.
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24. Case Study
 In such a case, the contractor would have incorporated a sum
for such supervisory fees as per the construction program.
 Employer wrote to contractor referring following clauses of
the contract, that he is responsible for additional cost.
Rate of progress
If for any reason directly or indirectly attributable to Contractor, Employer is of the opinion that
progress of theWork is delayed or progress is not being maintained on items which, if no actions
were taken, would affect the ability of Contractor to achieve Substantial Completion Date and/or
Completion Date, Company shall notify Contractor that it has failed to ensure the execution of the
work and Contractor shall within seven (7) calendar days from the date of the notice take all
steps as are necessary, subject to the consent of Employer or, in the event of failure to do so, shall
take such reasonable steps as Employer may instruct in writing to expedite progress so as to
correct such deficiencies in the execution of theWork as specified in the notice from Employer.
Contractor shall not be entitled to an extension of time and/or additional cost for taking such
steps. If any instruction issued by Employer pursuant to this sub-article causes Employer to incur
additional costs, such costs shall be recoverable from Contractor by Employer and may be
deducted by Employer from any monies due or to become due to Contractor.
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25. Case Study
Right to recover cost
Where Contractor is in default or, through no fault of Employer,exceeds
the maximum duration for application of the penalty, referred to in
Article ….., and regardless of whether or not Employer shall have
imposed penalties, Employer shall be entitled to recover from
Contractor costs incurred by Employer as a result of this. In addition,
Employer shall have the right to impose any other penalties as set out
elsewhere in the Contract.”
 Contractor argued that;
 It is the Contractors position Clause for Rate of Progress deals
with situations where completion on time is at risk and the Employer
expressly notifies and instructs the Contractor to take specific recovery
measures. It is the Contractors position aforesaid clause does not
provide a blanket entitlement to the Company to contra charge
supervision costs that the Company incurs.
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26. Case Study
 Contractor argued that;
 The Employer shall prove that additional supervisory cost is directly due to out
of working hours.
 The contractor is in delay due to his culpable delay.
 Employer must prove that those overtime charges are not covered under delay
damages defined in the Contract and actual damages due to such delay are over and
above the LDs which has been already imposed under the Contract.
 Employer needs to demonstrate that its costs exceed that LDs otherwise
Employer is seeking to achieve double recovery and unjust enrichment.
 This case clearly illustrates;
 The advantages of having proper LD provision in contracts.
 The difficulty in getting damages for breaches under the contract when it is not
specified.
 Importance of correct reference to provision of contract for a particular issue.
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27. Conclusion
 Damages are one of available remedy for breach of contracts and
when it genuinely pre-estimated at the time of entering in to the
contracts it could be a LD.
 Once the LDs are far exceeding and unconscionably higher than the
loss for a particular breach that could have been estimated, it may
construe as a penalty.
 Penalties are not enforceable under most of common law systems.
 It is important to estimate LDs as accurate as possible.
 In some standard conditions of contracts, certain conditions of
precedent to be followed to establish correct LD claim.
 The law applicable to LDs in GCC countries is substantially different
than common law.
 Such legal provisions allow courts to adjust agreed LDs/Penalties to
actual loss suffered.
.
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