Understanding Liquidated and Ascertained Damages (LADs) in UK Construction Contracts
Liquidated and ascertained damages (LADs), also referred to as liquidated damages (LDs), are a predetermined measure of damages agreed upon by parties in a contract. LADs are mainly employed to address culpable delays but can also be applied in cases of contract breaches. They are often calculated as a fixed amount per period, such as £1,000 per week, and can be applied to both subcontracts and main contracts.
The Purpose of Liquidated Damages
Liquidated damages are designed to provide a fair representation of losses when actual damages are difficult to determine. For instance, if a party in a contract were to leak confidential pricing information, it could fall under the liquidated damages clause. Since the true market value of the leaked information may be challenging to ascertain, liquidated damages allow parties to estimate the cost of such a breach in advance.
Benefits of Including a Liquidated Damages Clause
A liquidated damages clause offers numerous advantages, such as predictability. Both parties can negotiate and agree on a figure they believe is fair and reasonable. It serves as an affordable form of insurance against contractor breaches.
In case of a breach, the owner can quickly calculate the damages without the hassle of proving actual damages, which can be a complicated, lengthy, and expensive process. Moreover, the clause allows the owner to limit damage claims, enabling them to assess the level of risk involved and plan accordingly.
Time at Large and the Prevention Principle
A party facing a claim for LADs may argue that time is ‘at large’ under the contract. If a delay event caused by the employer occurs and the contract does not adequately address it, the completion date may no longer be valid, and the contractor’s obligation may change. This situation is known as the ‘prevention principle,’ which states that no party can benefit from a failure of compliance when they have prevented the other party from complying through their own actions.
Beware of Penalties
Courts often uphold penalty clauses against defaulting parties, but the clause must impose an obligation on the defaulting party that reflects the legitimate interests of the innocent party. In many cases, this means compensation will not exceed the compensation for the breach. However, this is not always the only legitimate interest innocent parties may have in performance.
The test to determine the difference between LADs and penalties is whether the clause amounts to a genuine pre-estimate of loss. The criteria for this test were outlined in the case of Cavendish Square v El Makdessi and ParkingEye Ltd v Beavis [2015] UKSC 67.
When do Liquidated Damages Amount to a Penalty?
The Supreme Court clarified the law in 2015 when considering Cavendish Square Holding v El Makdessi and ParkingEye v Beavis. In these cases, liquidated damages must be a ‘genuine pre-estimate’ of loss. Liquidated damages can no longer be penalized if the innocent party loses liquidated losses. To avoid being considered a penalty, the innocent party would have had to suffer the compensation amount.
The Importance of Time in Construction Contracts
Construction contracts typically include provisions for establishing a completion date for the contractor’s work. If no date is specified for LADs, they will not be chargeable since there is no fixed completion date. Extensions of time can benefit both parties and can be useful from both the contractor’s and employer’s perspectives.
Subcontracts and Liquidated Damages
Contractors often attempt to pass down liability for LADs to their subcontractors, but this can be difficult. Several standard forms avoid LD clauses, and calculating the impact of one subcontractor’s delay on the progress and
cost of others can be challenging. Loss and expense resulting from delays might include multiple elements, with the first two being relatively straightforward to estimate. However, predicting the impact of one subcontractor’s delay on others’ work can be difficult.
Limiting the Scope of the Penalty Rule
The rule against penalties does not apply to payments made under a contract. If a clause in a contract breaches a primary obligation rather than serving as a remedy for a breach, it should not be considered a penalty. The test is whether the sum is payable as a secondary obligation, or as a consequence of a breach.
The Importance of Keeping Records
When a dispute arises, having a record of discussions about the liquidated damages clause can be helpful. Demonstrating that the other party fully understood the clause increases the likelihood of courts enforcing the clause.
Benefits of Liquidated and Ascertained Damages
LADs cap liability for specific breaches, regardless of actual losses incurred by the employer. This limitation of liability ensures that the liability never exceeds the agreed LAD figure. Both parties can then focus on handling other issues, such as the accuracy and duration of any culpable delay applied to a particular contractor. A well-implemented LAD clause also serves as a strong deterrent against breaches of contract.
In conclusion, liquidated and ascertained damages play a crucial role in UK construction contracts, particularly for subcontractors working with main contractor clients. By understanding the intricacies of LADs and their benefits, subcontractors can navigate contractual obligations more effectively and protect their interests in case of breaches or delays.
Our How to read a Construction Contract – A Quick Guide might help explain more on the contract
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