Liquidated Damages: Where are we now?

First, a reminder of what ‘liquidated damages’ means, and a reminder of a key distinction.

• A contract between X and Y provides that if X is in breach of contract in some manner then X will pay a pre-determined amount to Y. That amount is described as ‘liquidated’ because it has already been ascertained, it needs no assessment, and as ‘damages’ because it compensates Y for the consequences of the breach of contract.
•  On the other hand, a contract between X and Y provides that if X voluntarily elects to take, or not to take, a certain action, then X will pay a pre-determined amount to Y. This payment does not represent a form of liquidated damages; there is no breach of contract by X, it is simply the agreed cost associated with X’s exercise, or foregoing to exercise, a contractual right. Examples include an obligation to make a termination payment where X elects to terminate the contract for convenience, or to make a payment under a ‘take or pay’ obligation where X elects to ‘pay’ rather than to ‘take’.

The enforceability of liquidated damages provisions in contracts has always been subject to some uncertainty because of the risk that the amount involved might be determined not, after all, to be a form of compensation for the consequences of the breach but, instead, a penalty because the amount involved is judged to bear no relation to the consequences of the breach and accordingly to be unconscionable/oppressive and unenforceable as matter of public policy.

Whilst there are many straightforward examples of both enforceable liquidated damages clauses and unenforceable penalty clauses, the concern for all parties to a contract – and no doubt their lawyers – arises when the amount involved falls into that grey area in the middle and, in the absence of a bright line between the two, any guidance from the courts is always welcome. This is particularly the case given the frequent temptation for the party with the likely benefit of this provision to try to push the amount involved as high as possible whilst still being assured of its enforceability.

So where are we now?

In Eco World -v- Dobler, Dobler contracted to carry out certain works to three residential tower blocks (A, B, and C) under what was basically a JCT Design & Build contract and accepted a liquidated damages clause which applied to a “delay in the completion of the Works beyond the Date for Completion” of £nil for the first 4 weeks and £25,000 per week after that up to a maximum of 7% of the contract sum. Eco World took over Blocks B and C in June 2018 but did not take over Block A until December 2018.

Dobler argued that as the “Works” meant all of the works (i.e. all three blocks), then £25,000 a week was the agreed sum payable for a delay in completing all three blocks and so was an unconscionable or extravagant sum to pay amounting to a penalty when the delay only related to one block.

Dobler’s argument did have some support, previous cases having highlighted that a liquidated damages provision purporting to provide for the payment of the same amount in the event of one of a wide range of breaches occurring, or even regardless of the nature of the breach (e.g. a payment for “any breach”) logically could not represent an amount based on a calculation of the actual damages likely to be suffered by the innocent party, as that amount must vary depending on whether the breach was serious or trifling or somewhere in between.

But the court did not agree with Dobler and held that the provision was not unconscionable or extravagant so as to constitute a penalty because:

• Both parties negotiated the contract terms using external lawyers. The rule against penalties is an exception to the general freedom of parties to negotiate their own contract terms and the courts should be reluctant to interfere with that freedom particularly when the provision has commercial benefits for both parties.
• Eco World had a legitimate interest in all of the ‘Works’ being completed by the completion date and not simply some of the blocks. Delay to one of the blocks could be seen to affect the project as a whole including the other blocks.
• Quantifying damages would be difficult, and providing for liquidated damages avoided that difficulty notwithstanding that the amount was a ‘global’ figure.
• The level of the liquidated damages, at £25,000 a week and capped at 7% of the contract sum, was not (and was not argued to be) unreasonable or disproportionate to the losses actually suffered or likely to be suffered.

The ‘legitimate interest’ rationale is the one which was adopted by the Supreme Court in Cavendish Square -v- El Makdessi in 2016: “the correct test for a penalty is whether the sum or remedy stipulated as a consequence of a breach of contract is exorbitant or unconscionable when regard is had to the innocent party’s interest in the performance of the contract“. Prior to the Cavendish Square decision, the test had been, more or less, whether the liquidated damages represented ‘a genuine pre-estimate’ of the loss to the injured party arising from the breach, even if that estimate was at the ‘top end’ of any such estimate, or whether the amount involved went above and beyond that so that it was not any form of genuinely compensatory damage but was simply a punitive consequence of the breach i.e. a penalty.

It is interesting to see the ‘legitimate interest’ approach being applied in this case to justify the liquidated damages provision as valid and enforceable on the basis of the impact of the delay (actual or potential) on the project as a whole, notwithstanding that two of the three blocks had been completed on time and only one block delayed and that the same amount would have been payable for a delay to all three blocks.

Combining the ‘legitimate interest’ argument with the ‘quantifying damages would be difficult, and providing for liquidated damages avoids this difficulty even if the amount is a global figure’ argument add considerable strength to the likely enforceability of similar provisions including where the parties may have favoured simplicity over granularity, although parties would still be well advised to note the court’s reference to the context of both parties have taken external legal advice (and hence being able to understand the financial implications of a ‘one size fits all’ payment – which was also a relevant factor for the court in GPP Big Field –v- Solar EPC Solutions in 2018).

The Supreme Court’s decision in Triple Point Technology -v- PTT provides welcome clarity as to what happens when the period covered by the liquidated damages ends – does the innocent party then have no further remedy or can they then claim general damages?

The liquidated damages clause in this case provided for a payment by Triple Point Technology as the software contractor for a delay in its delivery of the work of 0.1% of the value of the undelivered work from the due date for delivery “up to the date PTT accepts the work”. Triple Point was significantly late in delivering its work and so PTT terminated the contract and claimed both liquidated damages for the delay and general damages for breach of contract in relation to the contract termination.

The court was asked to decide what happens when there is no acceptance of the work and instead the contract is terminated.

The Supreme Court confirmed what was the previously understood position, namely that the innocent party can claim liquidated damages for the delay up to termination including for work that was never completed and can then claim general damages for its termination losses. The liability to pay the liquidated damages is triggered by the delay and is not dependent upon whether or not the work is then actually completed and accepted.

This decision is welcome both for confirming the previously understood position (bearing in mind the number of standard form contracts which contain liquidated damages provisions based on the orthodox position) and for retaining the simple damages position that liquidated damages for the delay apply up to termination and general damages can be claimed for breach of contract in relation to any post-termination losses. It should be noted, however, that – as with all liquidated damages provisions – the decision (if not the principles applied) in this case may have been different if the parties had agreed to different contract wording.

One final point: the clause in the Triple Point Technology -v- PTT case actually stated that Triple Point Technology would be “liable to pay the penalty at the rate of …” We would always recommend not referring to a ‘penalty’ in a liquidated damages provision – it cannot be helpful!

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