PLC Construction blog: liquidated damages - fun and games

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Summary: With the London 2012 Olympics now just around the corner, only time will tell whether the hotly negotiated liquidated damages (LADs) provisions in many “Games-related” contracts will be put to the test. We are involved in a number of projects where the timing of completion is absolutely critical, given the impending Games and the sheer number of visitors these will bring to the capital.

Contracts for retail, stadia, hotels and infrastructure have all been programmed and negotiated with the Games in mind. It is worth pausing a moment to consider the role of liquidated damages in these contracts and whether, given the extraordinary circumstances, they should be viewed in a different light.

What is the issue? 

We shouldn’t forget that a key purpose of an LADs clause is to protect the contractor. If the parties cannot or do not agree a pre-determined amount as representing the “loss” that the employer will suffer or incur as a result of late delivery of a project then, in the event of a delay for which the contractor is responsible, the employer will be entitled to recover general damages to compensate it for its losses. LADs can effectively cap a contractor’s exposure for late delivery. 

On the other hand, the benefit for the employer of LADs is that they overcome the need for it to “prove” its claim for general damages. However, in relation to some “Games-related” contracts the particular issue has been the level of LADs required by employers. In quantifying their potential losses from missing out on the golden goose, employer clients are arriving at very high figures that are unacceptable to contractors. In addition, “Olympic” clients need to avoid granting extensions of time wherever possible. Therefore the contracts contain limited grounds for extending time and require the contractor to accelerate the works rather than claim an extension of time where a “relevant event” occurs. 

“Faster, higher, stronger” is, not surprisingly, proving unpalatable for contractors. In other cases, in particular for contracts relating to the Olympic Park itself, it is almost impossible to put a monetary value on delay risk. 

We all know the long established rule that LADs must be a genuine pre-estimate of loss. If they penalise a contractor, rather than compensate the injured party, the clause may be unenforceable. But this isn’t the case here. In a recent case, the judge said that a clause will not be a penalty as long as it is commercially justifiable, and it will be commercially justifiable if it provides a balance between the parties on the occurrence of the event in question. Are these high levels of LADs commercially justifiable? As long as they are not “extravagant and exorbitant” then yes, in the circumstances, I think they are. The problem is that the “losses” which employers will suffer if these projects are not completed on time are simply too much for a contractor to bear. The issue comes down to how the parties share the risk. 

Calculating losses

One interesting point that has arisen is whether LADs can reduce where the employer takes over part of the works. Suppose an employer is able to open part of a hotel, leaving a number of rooms unused. Many standard form contracts include a provision reducing LADs to reflect the employer taking partial possession, which may work well in these circumstances. However, the LAD provisions must not be incompatible with the rest of the contract. The 1983 case of Bramall and Ogden v Sheffield City Council included a standard partial possession clause and, in addition, the contract provided for LADs to be paid at a specified rate per week for each incomplete dwelling. The court held that the LADs were inconsistent with the partial possession provisions and operated as a penalty. That is not to say that LADs levied against unfinished hotel rooms could not work, but they must be drafted so as not to cut across any of the provisions relating to sectional completion or partial possession. The contract must be viewed as a whole. 

What else can the parties do? 

As ever, the best way of avoiding delay-related disputes is to ensure that the project is managed effectively. Progress should be monitored against the programme and any delay or programming issues dealt with as they arise. 

LADs are often used as a stick with which to beat contractors for delayed completion. However, offering incentives to deliver the project on time can be just as effective. Employers should consider whether it is appropriate to offer a “bonus” for early completion of the project or certain key elements. 

Another way of effectively managing delay risk is to provide for the project to be completed in sections, rather than relying on the partial possession provisions contained in many standard form contracts. Although partial possession can be a useful tool in allowing the employer to carry on with its intended business, to a greater or lesser extent, such provisions are often not compatible with LAD provisions, as mentioned above. The bigger problem is that partial possession only operates by consensus: an employer cannot force its contractor to complete a relevant part of the works by a particular date, or levy LADs if it fails to do so. For these reasons, if it is possible at the outset to identify parts of the work that might be completed in phases, then sectional completion (as opposed to partial possession) is a more robust contractual tool with which to manage the project, with LADs apportioned appropriately.

This blog was first published by PLC Construction as part of our regular construction blog series in which we share our practical experiences of working in construction and engineering and give our opinion on the current and future legal developments that shape and will shape the industry. 

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