Out-Law Guide 11 min. read
16 Jun 2023, 11:05 am
The differences between liquidated and general damages for breach of a construction contractor’s obligations to complete works on time can be difficult to discern.
This guide examines the meaning of both terms, explains important differences, looks at how these differences have been illustrated in recent case law and offers some key practical takeaways.
Liquidated damages (LDs) are commonly defined as a “fixed or agreed sum, that shall be paid as damages for some breach of contract”. In practice, and a good example of a ‘belt and braces’ approach, some contracts also refer to them as ‘liquidated and ascertained damages’ (LADs).
LDs are used as a contractual term relating to delayed completion of construction works. LDs provide for the payment of a specific and pre-determined amount, in the event of late completion. LDs can, however, also relate to obligations other than time, such as the obligation to provide a programme.
General damages (GDs) are a more commonly recognised form of damages for any breach of contract claim, including delayed completion. If GDs apply, if a contractor or subcontractor completes the works after the contractually required date, then the contractor or subcontractor would generally be liable for GDs for the actual losses caused by that delay.
That liability would however be subject to usual contractual damages requirements such as foreseeability, remoteness and the duty to mitigate loss, for example.
For LDs to apply, specific drafting is needed in the contract. In the absence of any – or any enforceable – express LD provisions, then GDs will apply to late completion. In that sense, GDs are the legal ‘default’, which applies unless express LD provisions are drafted into the contract.
The amount of LDs has to be agreed and properly incorporated into the contract before it is signed. By contrast, the amount of GDs will not be known until the delay has actually occurred and the amount of loss caused as a result of the delay been suffered. As a result, LDs are often a pre-contract estimate of likely, but not actual, losses. The amount of actual loss suffered may thus be greater or less than the amount of those LDs.
LD provisions are typically found in main contracts and are much less common in sub-contracts. This is perhaps surprising given the difficulty of proving that one particular late subcontractor causes a whole project to overrun; and the greater willingness of the courts to enforce LD provisions provided that they are ‘commercially justifiable’.
When a contract contains an LDs provision, and that provision is found to be enforceable, liquidated damages will usually be an exhaustive remedy. A claiming party cannot claim more than the LD level simply because their actual losses are much greater.
To claim GDs, the injured party must prove that the other party’s breach caused the loss it suffered. This is typically determined by the courts, or any other chosen method of dispute resolution between the parties.
GDs will have to comply with usual contractual damages claims requirements – such as foreseeability, remoteness and the duty to mitigate loss. This does not apply to LDs, which provided they protect a legitimate commercial interest and are sufficiently clear and certain, will be enforced.
Although not always the case, in practice often LDs are ‘capped’ at a certain level or period, whereas GD for delay are not. GDs are however sometimes subject to an overall liability cap.
Amount is determined after delay occurs, based on actual losses
Must be foreseeable and not too remote
Amount is agreed before – and incorporated into – the contract
No foreseeability requirements. Losses are pre-determined and will be specified within LDs provision of the contract
A party claiming general damages is required to prove its actual losses caused by the delay so will rely on multiple factors, such as
No requirement to demonstrate or even suffer actual loss
Amount is uncertain until loss suffered so it is difficult to predict what you may end up recovering (or paying out)!
Amount stated within the contract, and parties will therefore have certainty on their exposure/recovery in the event of a breach.
When claiming general damages, a claimant is under a duty to mitigate losses
Since liquidated damages are pre-determined and agreed, there is no need for a claimant to prove it has sought to mitigate its losses
Usually this is the default position in subcontracts – although due to the foreseeability requirement the subcontract may identify the amounts of Main Contract LDs recoverable as subcontract GDs.
Commonly found in Main Contracts
Provided the loss has been incurred and is recoverable etc, in theory no limit on the amount due
Must be at a level that protects a legitimate commercial interest and be sufficiently clear and workable – see case illustrations below
Sometimes subject to an overall liability cap for all damages (e.g. including for delayed completion)
Often in practice capped to a limited period, amount or per centage of the contract sum.
Not exhaustive – GDs can include all sorts of actual, recoverable losses e.g. consequential losses - unless expressly excluded
Usually an exhaustive remedy for delay
While this was not a construction case, it did contain an LD provision as to the amount by which a share sale price would be reduced if the seller breached restrictive covenants. The seller breached those covenants but argued that the LD provisions were punitive and therefore unenforceable.
A similar argument was raised in the ParkingEye case, where Mr Beavis appealed a decision relating to a parking charge of £85, for overstaying the permitted period of free parking. Mr Beavis argued that the charge was a penalty, rather than a genuine pre-estimate of the parking company’s loss - and was thus unenforceable.
In deciding both cases jointly, the Supreme Court determined that the test to distinguish that which is a penalty from that which reflects a genuine pre-estimate of loss is whether the provision “imposes a detriment out of all proportion to any legitimate interest of the innocent party in the enforcement of the primary obligation.”
In effect, the court held that in deciding whether an LD clause is punitive, it must be shown that the relevant clause is extravagant, unconscionable, or otherwise out of all proportion to the legitimate commercial interests of the innocent party. However, there is no automatic presumption that a clause is penal simply because the damages it provides for may be greater than any actual loss.
Eco World was a property developer that engaged Dobler for façade and glazing works for new residential blocks. The works were not divided into sections. However, Eco World was entitled to take over part of the works prior to practical completion of the whole project, and was entitled to LDs for late completion – subject to a LDs cap.
When the works were not completed by the completion date, Eco World took over the unfinished part. Interestingly, it was Eco World that argued that the LDs were unenforceable. Contrastingly, Dobler argued that the LDs were valid, or, if invalid, it provided a cap on the liability for GDs. This illustrates the point that, LDs provisions can work in favour of either party.
Applying the El Makdessi case above, the judge found that the LDs provisions were enforceable because the contract provided for partial takeover of the works even without any mechanism for reducing the level of LDs payable. The LDs clause was not extravagant, exorbitant, or unconscionable.
Following El Makdessi, courts are far less likely to find an LDs provision to be penal, and instead will seek to enforce the contract as negotiated, particularly where both parties can negotiate their respective positions.
This case concerned commodities trader PTT, which sought LDs for delays to works under a contract with a software company called Triple Point. Following considerable delays, and various disputes over payment, Triple Point suspended work. PTT argued wrongful suspension and terminated the contract.
Triple Point brought proceedings for payment of unpaid invoices, whilst PTT counterclaimed for, amongst other things, LDs for delayed completion of the Works, up to the date of termination.
The Supreme Court overturned the earlier Court of Appeal judgement, and held that LDs are payable even where works were never completed, or accepted by the employer. The Court of Appeal’s determination that works needed to be completed for LD provisions to apply was “inconsistent with the commercial reality and the accepted function of liquidated damages”; and LDs accrue up until the point of termination by the employer, and not until the works are completed by the new contractor. Post termination, GDs apply.
LD provisions are difficult, given recent case law, but not impossible to overturn in practice. LDs bind both parties and are usually an exhaustive remedy for delay – so think carefully of different scenarios caused by project delay and the losses delay to completion could cause before agreeing the amounts for LDs.
Particular care should be given to ensure the pre-determined amount is not extravagant, unconscionable, or otherwise out of all proportion to the legitimate commercial interests of a party – otherwise it is likely to be a penalty and unenforceable.
Consider whether the certainty of a pre-agreed compromise for LDs would be better or worse than proving actual delay losses as GDs. For example, given law changes encouraging enforceability, LDs might be a better solution in subcontracts on multi-trade projects than GDs.
Think carefully about the relationship between delay, LDs and provisions such as caps on liability, rights to terminate, partial possession and certification of completion. They might not all work in practice as intended.
Both parties should be aware of the enforceability of an LD provision. As seen in the Eco World case, it is not necessarily always in the employer’s interest for the LD provision to apply.
Co-written by Naveed Hanif of Pinsent Masons.
12 Jan 2023
16 Jan 2023