The interpretation of a liquidated damages provision, and in particular how this provision operated in circumstances of termination prior to completion (or acceptance) of the works. This decision will have implications across contract law but in particular in construction contracts. Ruth Keating provides a summary of the facts and decisions of the High Court and Court of Appeal in the first post, here.

The Liquidated Damages Clause

The liquidated damages clause (Article 5.3) provided as follows:

“If CONTRACTOR fails to deliver work within the time specified and the delay has not been introduced by PTT, CONTRACTOR shall be liable to pay the penalty at the rate of 0.1% (zero point one percent) of undelivered work per day of delay from the due date for delivery up to the date PTT accepts such work…”

(Emphasis added.)

The misuse of previous precedents on contract interpretation

As summarised in our first post, the Court of Appeal saw much force in the House of Lords’ reasoning in British Glanzstoff Manufacturing Co Ltd v General Accident, Fire and Life Assurance Corpn Ltd[2] (“Glanzstoff”) and held that in some cases the wording of a liquidated damages clause (including Article 5.3 in this case) may be so close to the wording in Glanzstoff, that the House of Lords’ decision is binding (Court of Appeal at [109]). In such cases, the liquidated damages clause would not apply at all in circumstances of termination (Category 1 cases).

The Supreme Court did not agree, finding that Glanzstoff, rather than laying down any principle, was a case on the interpretation of a single contract. Lady Arden further gave guidance on the limited circumstances when precedents concerned with the interpretation of contracts would be binding. Such precedents deal with “market-accepted wording or clauses from some standard form recognised in the industry”. These would bind in later cases involving the same wording [30]. Emphasising this point, Lady Arden confirmed, “[w]ith those exceptions, in general the decision of one case as to the meaning and effect of a clause cannot be binding as to the meaning and effect of even a similar clause in another case.”

The importance of commercial reality and preserving accrued rights

As further summarised in our first post, the Court of Appeal also determined that it should not be assumed that a liquidated damages clause had any operation beyond the precise event for which it provided, suggesting that liquidated damages clauses should be interpreted based upon precisely what they state.

The Supreme Court again did not agree. In Lady Arden’s view the difficulty with the Court of Appeal’s approach was that it was inconsistent with “commercial reality” and the “accepted function of liquidated damages”[35]. Parties agree a liquidated damages clause to provide a remedy that is predictable and certain for a particular event (e.g. delay in completion). Lady Arden held that parties must be taken to know the general law, that liquidated damages come to an end on termination (at which point the parties’ contract is at an end and damages are at large) [35]. Thus parties do not have to specifically provide for the effect of termination in respect of liquidated damages. They can take that consequence as read.

In short, the Supreme Court found that when there is a liquidated damages provision which specifically provides that it ceases on completion or acceptance of works, this is in addition to (as opposed to substitution for) it ceasing on termination [35] – [36]. Importantly this reading met commercial common sense and prevented the unlikely elimination of accrued rights.

Overall

In summary, the following conclusions can be taken away from the Supreme Court Judgment on Issue 1:

1. A previous judgment cannot be binding as to the meaning and effect of a contractual clause, unless they fall within certain specified exceptions (i.e. market accepted wording/ standard form contract clauses) [30].
2. In circumstances of termination, liquidated damages clauses are to be presumed to apply up to the date of termination, unless the clause specifically provides differently [35] (Category 2 of the three Court of Appeal categories – as discussed in our first post).
3. When interpreting contracts, regard must be had to commercial reality [35].
4. Throughout the judgment, the Supreme Court (in particular Lady Arden and Lord Leggatt) signalled their support for liquidated damages clauses, which may have implications for the future interpretation of such clauses.

Our next post will consider Issue 2 and key takeaways from the court’s judgment.

[1] [2021] UKSC 29; [2021] 3 WLR 521.

[2] [1913] AC 143.