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Shake up on the application of liquidated damages clauses following termination of a construction contract

Most construction contracts will contain a clause which requires the contractor to pay a rate of ‘pre-agreed’ delay damages (“liquidated damages”) to the client / employer in circumstances where the contractor fails to achieve practical completion by the relevant completion date (or sectional completion dates) set out in the contract. Liquidated damages, as opposed to general damages, do not require the claimant to prove that the losses claimed have actually been suffered (subject to the overriding requirement that the rate of liquidated damages is not ‘unconscionable’).

Where a contractor’s employment is terminated before the works have been completed the recent and most commonly accepted position in respect of the deduction of liquidated damages had been that the client was entitled to:

  • recover liquidated damages for delay at the contractual rate up to the date when the contract is terminated; and
  • general damages thereafter.

The legal effect of liquidated damages clauses has long been a point of contention and its application  has been argued many times over. There has been a plethora of case law on the point although the application of liquidated damages clauses by the courts has seen differing results with inconsistent reasoning and varying decisions and approaches being adopted.

Historically, in the case of British Glanzstoff Manufacturing Co. Ltd -v- General Accident, Fire and Life Assurance Co. Ltd 1912 SC 591 (Court of Session) and 1913 SC (HL) 1, it was held that the liquidated damages clause in question did not apply in circumstances where the contractor’s employment had been terminated and the works had been completed by an alternative contractor.

This position was accepted for some time. From around 2006 however there then followed a number of cases in which Glanzstoff was not cited and the position set out at (i) and (ii) above - that the clause only applies up to termination of the contract - became the generally accepted position.

There have also been cases where it has been held that the clause continues to apply until the second contractor achieves completion.

This confused position has now been considered in the very recent judgment handed down by the Court of Appeal in Triple Point Technology, Inc. -v- PTT Public Company Ltd [2019] EWCA Civ 230 which has provided some clarity on the issue. 

The Court decided that where a contractor’s employment has been terminated before the works have been completed, liquidated damages cannot be applied (including for period (i) above - the period of delay prior to termination). Instead, the terminating client must establish the actual losses arising from delay and claim these as general damages.

The Court in that case held that “there is no invariable rule that liquidated damages must be used as a formula for compensating the employer for part of its loss.”  The Court considered that it may be more logical and consistent with the parties’ bargain to apply the ordinary rules for assessing damages for breach of contract.

The court noted that the above will invariably turn on the precise wording of the liquidated damages clause in question.

In terms of the implications of this case on construction contracts, where the wording of the clause links the application of liquidated damages to practical completion by the initial contractor (as is the case under many industry forms of contract such as JCT and FIDIC contracts), then the liquidated damages clause will not apply in circumstances where the initial contractor’s employment was terminated prior to practical completion.

This does not mean that the client / employer is left without a remedy for non-completion as it will still be able to claim damages in the usual way by proving the actual loss it has suffered by reason of the delay.

Where the actual loss suffered (or likely to be suffered) is significantly less than the liquidated damages which have accrued, then careful consideration will need to be given as to whether the client / employer should terminate the contract (assuming it can satisfy the grounds to terminate the contract) as it would effectively be forfeiting its right to claim the accrued liquidated damages. 

The decision in this case also opens the door to contractors, who face a large liquidated damages bill, potentially electing to unlawfully terminate the contract in the hope that any actual loss suffered by the employer will be less than the liquidated damages.

Given the prevalence of the above wording in commonly used printed forms of construction contract (such as the JCT), this case can be seen as a significant development which is likely to reverberate through the industry. Going forward we expect to see amendments to such contracts to prevent liquidated damages clauses ceasing to apply should it prove necessary to terminate a contractor’s employment before the works have been completed. 

This article was written by Lee Ward, Solicitor in Ashfords’ Construction and Infrastructure Department

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