A liquidated damages clause is, shortly put, one stipulating the money payable as damages for loss caused by a breach of contract, irrespective of loss suffered. Practitioners will be aware also that albeit a liquidated damages clause, by definition, may not amount to an exclusion clause or limitation of liability clause (see e.g.: K Line Pte Ltd v Priminds Shipping (HK) Co Ltd[1]), its particular drafting may nonetheless indicate an intention of the parties for a provision to function both as a liquidated damages clause and also a limitation of liability clause.

The certainty and enforceability (as opposed to penal, uncertain and inoperable) of liquidated damages clauses in principle, has commonly been the subject of elaborative discussion by the courts, see e.g.: Bramall & Ogden v Sheffield City Council[2]; Taylor v Woodrow Holdings Limited v Barnes & Elliott Limited[3]; and De Havilland Aircraft of Canada Ltd v SpiceJet Ltd[4]. The circumstances in Eco World however concerned the operability of such as clause, viewed specifically in the context of a part take-over of contract works and part performance.

Basic Facts

Eco World concerned a Part 8 claim made for declaratory relief in connection with the proper construction of the liquidated damages provisions of a construction contract (for the design, supply and installation of façade and glazing works) entered into between EWB (Claimant) and Dobler (Defendant) – in circumstances where EWB had taken over part of the contract works (thereby, signposting their agreement to completion) prior to the practical completion of the works in full. Of particular note was that the contract had permitted EWB to take partial possession of the works ahead of practical completion, albeit this event was not specifically provided for by the contract in terms of reduced liquidated damages. In arguing that the liquidated damages clause was invalid and inoperable, EWB claimed an entitlement to general damages for delay, including substantiated damages in excess of the liquidated damages cap.

Central Issue

The court was invited to determine the validity and enforceability of the liquidated damages clause, and alternatively, to consider an argued entitlement to claim general damages for delay (and, if so, address whether any recoverable damages would be limited by reference to any void and/or unenforceable liquidated damages clause). Centrally, the court was tasked with declaring whether, when properly construed, the relevant clause is penal and/or unenforceable, having regard to contractual provisions governing part take-over of works and the (in)significance of a mechanism for adjusting down the level of liquidated damages to reflect part take-over.

Discussion

The liquidated damages clause read as follows:

“2.32.1      If the Trade Contractor fails to complete the Works or works in a Section by the relevant Date for Completion of a Section or the Works, the Employer may, not later than 5 days before the final date for payment of the amount payable under clause 4.16, give notice to the Trade Contractor which shall state that for the period between the relevant Date for Completion of a Section or the Works and the date of practical completion of the Works or Section that:

2.32.1.1           he requires the Trade Contractor to pay liquidated damages at the rate stated in the Trade Contract Particulars, or lesser rate stated in the notice, in which event the Employer may recover the same as a debt; and/or

2.32.1.2           that he will withhold or deduct liquidated damages at the rate stated in the Trade Contract Particulars, or at such lesser stated rate, from sums due to the Trade Contractor.

2.32.2       If the Employer intends to withhold or deduct all or any of the liquidated damages payable, an appropriate Pay Less Notice must be given by or on behalf of the Employer.”

The leading authority today on liquidated damages is Cavendish Square Holding BV v Makdessi[5] in which the Supreme Court identified as “the real question when a contractual provision is challenged as a penalty” being “whether it is penal, not whether it is a pre-estimate of loss” by which enforceability will depend on “whether the means by which the contracting party’s conduct is to be influenced are unconscionable or extravagant by reference to some norm”. The “true test” was there characterised as “...whether the impugned provision is a secondary obligation which imposes a detriment on the contract-breaker out of all proportion to any legitimate interests of the innocent party in the enforcement of the primary obligation.” Lord Hodge stated the test as follows:

“...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. Where the test is to be applied to a clause fixing the level of damages to be paid on breach, an extravagant disproportion between the stipulated sum and the highest level of damages that could possibly arise from the breach would amount to a penalty and thus be unenforceable. In other circumstances the contractual provision that applies on breach is measured against the interest of the innocent party which is protected by the contract and the court asks whether the remedy is exorbitant or unconscionable.”

Of some significance in Eco World, the judgment in Cavendish Square is important also for clarifying that the consequence of a liquidated damages clause being held a penalty is nothing short of rendering it wholly unenforceable (rejecting the earlier suggestion of the Court of Appeal in Jobson v Johnson[6] of partial enforceability on a reduced basis, reflecting any actual loss suffered by a breach).

O’Farrell J re-sounded the trite principles of interpretation in conjunction with a liquidated damages clause, accounting for:

• its natural and ordinary meaning,
• other relevant contractual provisions,
• the overall purpose of the clause, and contract,
• the circumstances known to or assumed by the parties at the date of the contract, and
• commercial common sense: Arnold v Britton[7].

The judge further observed that the liquidated damages clause, as drafted, contemplated a failure to meet: (a) contractual dates for completion of sections of works and/or (b) the contractual date for the whole of the works – but not for an alternative rate of liquidated damages applicable to any late completion affecting part of the works.  Similarly, the contract did not include a mechanism for adjusting the rate of liquidated damages payable after EWB effected part take-over. On this basis, the provisions were to be found clear and certain.

Applying then its natural and ordinary meaning, a failure by Dobler to achieve practical completion of the works was found to mean that EWB was entitled to liquidated damages at the rate set out in contract particulars.

It was observed that upon taking over of part of the works, EWB had effectively excluded Dobler from a part of the site, meaning also that Dobler was no longer obligated to carry out work in that same part. Dobler was however not entitled to any relief from liquidated damages to reflect the take-over, meaning that the full rate of liquidated damages continued to apply in respect of the reduced scope of outstanding works.

O’Farrell J affirmed that, in principle, a “one rate” liquidated damages clause is capable of remaining enforceable even in the event of part completion or part possession, without any related reduction in the liquidated damages payable. Drafting errors may of course import invalidity but the principle of such a provision remains an acceptable one.

Then followed the fundamental question of whether the clause, so interpreted, is penal and unenforceable. Here, EWB argued that the use of a “one rate” liquidated damages for late completion of any combination of blocks on the site, did not reflect the reality that different levels of loss would be incurred, or where EWB had taken over part of the works (see Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co[8] for earlier discussion of this potentially highly relevant factor, which could give rise to a presumption of a penal clause).

In applying the test in Cavendish Square to the facts, O’Farrell J found the liquidated damages clause not to be “unconscionable” or “extravagant” as to be penal. Rather, properly viewed, it was a secondary obligation imposing a detriment on Dobler, suitably proportionate to the legitimate interest of EWB in the enforcing the primary obligation of completing the works in accordance with the contract. Of note:

• the clause had been fully negotiated by professionals, meaning that the court should be slow to intervene in commercial freedoms, especially those which govern how risk of delay in works completion is managed (see also: Cavendish Square);
• EWB held a legitimate interest in enforcing the primary obligation of Dobler to complete the works as a whole, for any delay would likely impact on the work of following trade contractors and cause wider disruption to completion in full;
• quantification of the damages suffered by EWB would be arduous, in contrast to the ease of fixing in advance the liquidated damages payable for any late completion of works; and
• the level of damages was not shown in evidence to be unreasonable or disproportionate to the likely loss caused by late completion.

Notwithstanding the overall holding, O’Farrell J went on to address (and reject) Dobler’s alternative argument that even if the liquidated damages clause is penal and void, general damages should nevertheless be limited to the level of liquidated damages, by reference to the clause itself.

Conclusion

Eco World is especially helpful for its illustrative discussion of the proper interpretative approach to liquidated damages clauses, in application of the Cavendish Square principles together with the familiar rules which secure commercial freedom in negotiating and formulating certain contractual terms, which together, reflect the functionality of such clauses for major construction contracts. The depth of discussion also holds real merit: whilst invariably, contractual contexts will vary considerably, liquidated damages clauses will doubtless continue to serve many useful purposes, not least (as O’Farrell J underscored) for establishing, with required certainty, the sum of financial loss for delays as well as limiting contractor exposure to future liabilities whilst ensuring recovery for compensation. Eco World is a further aid in enabling and scoping their commercial importance.

Juan Lopez

[1] [2020] EWHC 2373 (Comm); [2021] Bus LR 213.

[2] [1983] 29 BLR 73.

[3] [2004] EWHC 3319 (TCC).

[4] [2021] EWHC 362 (Comm).

[5] [2015] UKSC 67; [2016] AC 1172 (at [31]–[35]).

[6] [1989] 1 WLR 1026.

[7] [2015] UKSC 36; [2015] AC 1619, per Lord Neuberger (at [15]–[23]).

[8] [1915] AC 79.