Liquidated damages: not negotiable

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Liquidated damages (“LDs”) clauses are par for the course in standard construction contracts. These clauses provide that a contractor is required to pay a pre-determined sum of money, as damages for breaching a particular term of a contract (eg failing to complete the works on time). LDs can benefit both parties to a contract by:

  • providing contractual certainty;
  • not requiring proof of loss;
  • simplifying disputes;
  • inducing performance; and
  • providing a cap on liability.

The topic of LDs is often a red flag to contractors, and so it should be. No contractor wants to be liable for LDs, regardless of the quantum. No amount of planning or program contingency can guarantee that a contractor will not fall behind schedule or miss critical milestones (such as practical completion). Some contractors seek to deal with this issue by simply ignoring it during contract negotiation. The contract is signed and put in the drawer until the project is delayed, and only then do they realise the extent of their exposure.

However, too often, the temptation for parties is to negotiate the sum of LDs at the time of entering into a building contract just as they would any other commercial term. Whilst it seems commercially ideal for the parties to ‘agree’ to the sum of liquidated damages, this is problematic for three reasons.

The first (and perhaps the basis for the second and third reasons) is that, in practice, any agreement reached will depend on the extent of the parties’ bargaining power. Ironically, large contractors with more commercial sway can often negotiate lower LD rates than small builders with no bargaining power (and no way of satisfying such large LD liabilities). This of course has its own inherent risks to the success of a project.

Secondly, at common law, liquidated damages must be a “genuine pre-estimate” of the loss that will be suffered by the non-breaching party in the event that the works are not completed in time. If the amount of LDs cannot be proven to be a genuine pre-estimate of loss as at the time of entering into the contract, it may be held to be a penalty at law and the LDs clause will be unenforceable.  So, if the negotiated LDs rate is too high, there is a real risk that it will be classified by a court as a penalty. But, to prove that a LDs provision is penal would require the aggrieved contractor to commence legal proceedings, which are expensive, stressful and time-consuming. Even then, the contractor may still be liable to the principal to pay such amounts of damages as the principal can satisfactorily evidence. For these reasons, in practice, the fine line between what is a ‘genuine pre- estimate’ and what is a ‘penalty’ is rarely tested.

Thirdly, if the negotiated LDs rate is too low, it may mean that the principal effectively ‘caps’ its ability to recover loss in relation to the particular breach of contract. LDs are usually the sole remedy in relation to a particular breach, so, once the breach occurs (eg failure to bring the works to completion by the date for completion), the principal’s entitlement to recover actual loss is limited to the agreed amount of LDs. A failure by the principal, at the time of entering into a contract, to properly assess the potential heads of loss that it will be exposed to for a later breach of contract can place a wronged principal in a very frustrating and costly position.

Further to the above, there are real dangers in agreeing LDs clauses which only provide for nominal or “nil” damages, or which state that the LDs clause is “not applicable”. As LDs are usually the sole remedy, such clauses may have the completely unintended effect that the contractor is absolved from any liability for damages for late completion or non-performance. In those circumstances, the principal should delete the LDs clause in its entirety and preserve its rights to rely on general damages.

LDs are a useful tool for risk allocation between parties but developers and contractors should ensure that LDs clauses are used properly and avoid the pitfalls set out above.

Time is money – the importance of drafting and contract administration

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The recent Supreme Court decision in Champion Homes Sales Pty Limited v DCT Projects Pty Limited [2015] NSWSC 616 provides a timely reminder of the importance of contract drafting and administration, particularly in respect of extension of time claims and liquidated damages.

Extensions of time

Ordinarily, a construction contract will set out a clear regime for a builder to claim extensions of time (EOTs). Often, builders are contractually time barred from making any claim for an EOT if they do not comply with the contractual regime.
In this case, the contract had the following EOT regime:

  1. The builder was required to give a written notice of a claim for an EOT, which detailed both the cause of the delay and the time claimed. The claim had to be made within 10 workingdays after the builder became aware of “both the cause and extent of the delay”.
  2. Assuming the builder complied with its notice requirements, the builder was entitled to the EOT claimed unless notice disputing the EOT was given by the principal to the builder within 5 working days of the builder’s notice, which detailed the reasons why the EOT was disputed.

The project was delayed. The builder submitted a number of EOT claims for different causes of delay, including variations and adverse weather.

In assessing whether the builder was entitled to an EOT, essentially, the Court assessed whether the builder had complied with the EOT regime under the contract. The Court found that the builder was entitled to give notice of its claim for EOTs in respect of variations when the variation work was completed because that was when the builder would become aware of both the cause and extent of its delay. Further, the Court found that the principal had failed to issue notices disputing the
entitlement to EOTs, in accordance with the contract.

Separately, the Court found that the builder was not entitled to EOTs claimed for adverse weather because the builder had not given notice of those delays in accordance with the EOT regime under the contract.

Ultimately, the Court found that the builder was entitled to a number of EOTs, which significantly reduced the principal’s entitlement to liquidated damages for the builder’s delay in achieving practical completion.

Liquidated damages

The builder attempted to defeat the principal’s claim for liquidated damages by relying on the ‘prevention principle’ to assert that the builder was prevented from completing the work by the time stated in the contract due to the conduct of the principal.

The Court did not accept the builder’s reliance on the prevention principle in circumstances where the contract set out a clear regime to claim EOTs and the contract provided for liquidated damages.

The Court relied on the decision of Cole J in Turner Corporation Ltd (rec and mgr apptd) v Austotel Pty Ltd (1994) 13 BCL 378, in which his Honour said:

“If the Builder, having a right to claim an extension of time fails to do so, it cannot claim that the act of prevention which would have entitled it to an extension of the time for Practical Completion resulted in its inability to complete by that time. A party to a contract cannot rely upon preventing conduct of the other party where it failed to exercise a contractual right which would have negated the affect [sic] of that preventing conduct.”

As noted above, the builder had failed to comply with the EOT regime for some claims. The Court found that the principal was entitled to liquidated damages, albeit for a much reduced amount, once EOTs (that had been properly claimed under the contract) were taken into account.

Issues to note for principals and builders

Contract drafting

In this case, to claim an EOT, the builder was only required to first notify the principal when it became aware of “both” the cause and extent of the delay. The Court accepted that the builder may only become aware of the extent of the delay for variations when the variation works have been completed. Thus, the principal only became aware of the extent of the delay to the date for practical completion once the variation works had been completed.

Principals should protect themselves by requiring builders to notify when they become aware of something that may cause delay (within 5 or 10 days), as a prerequisite to claiming an EOT. With respect to variations, any claim for a variation should include an EOT claim, including the extent of the delay claimed. Thus, the principal should be fully aware of the effect of a cause of delay/variation on the date for practical completion before variation works are carried out rather than getting a nasty surprise once variation works are completed.

Contract administration

Notwithstanding the above, the principal could have preserved its position in relation to the EOT claims by issuing a complying notice disputing the EOT claims within 5 business days. In response to a number of EOT claims, the principal did not do so, which was fatal to its defence to the EOTs claimed.

Further, the builder failed to submit timely EOT claims for adverse weather and the Christmas shutdown period, which disentitled the builder from claiming those EOTs.

Poor administration of a contract is often fatal, particularly contracts that include time bars. At the start of any project, principals and builders should inform themselves of the administrative requirements of the contract to ensure they protect their rights and entitlements.

Liquidated damages

Principals should note the restatement of the law in relation to the prevention principle. That is, the builder cannot rely on the prevention principle in circumstances where it has waived or failed to properly exercise its rights and entitlements under the contract.