Lessons from failure: agree delay damages

Given the likelihood of delays on a construction project, it makes good commercial and practical sense to pre-agree the compensation that the contractor will pay to the client if it is causes any delay to completion. These are called liquidated and ascertained damages (JCT) or delay damages (NEC). [This blog uses the latter name].

Using your contract to pre-agree the delay damages saves the time to determine your losses, court costs in pursuing a claim for breach of contract, and acts as a cap on the contractor’s liability. It benefits both partners to the contract. It is better to put a figure in for delay or other breach, however tentative, than suffer the vagaries of proving your losses in court or adjudication.

Are they payable?

Since 1914 there have been regular debates about whether a given level of delay damages are recoverable. The two defences to a claim for delay damages were (1) that you should have had an extension of time or (2) that the level of damages was a penalty.

The Dunlop case in 1914 set out some factors to take into account:

  • the words used are not conclusive – your terminology will not affect the court’s view
  • the essence of a penalty is an amount of money intended to deter your partner from offending
  • the essence of liquidated damages is a genuine pre-estimate of damage
  • it will be a penalty if it is extravagant or unconscionable in comparison with the greatest possible loss.

The court also said that:

It is no obstacle to the sum stipulated being a genuine pre-estimate of damage, that the consequences of the breach are such as to make precise pre-estimation almost an impossibility. On the contrary, that is just the situation when it is probable that pre-estimated damage was the true bargain between the parties.

The courts’ approach is to support the level agreed (another example of ‘don’t whine: read before you sign‘). This provides certainty for the parties and prevents unnecessary court interference in contracts between savvy businesses.

No nit-picking

Since the Dunlop case, lawyers sought “hypothetical situations where the effect of the application of the clause may be to produce a sum payable to the employer substantially in excess of the damage which the employer is likely to suffer.” [Philips v AG Hong Kong]

But the courts have countered with:

  • “… so long as the sum payable in the event of non compliance with the contract is not extravagant, having regard to the range of losses that it could reasonably be anticipated it would have to cover at the time when the contract was made, it can still be a genuine pre-estimate of the loss that would be suffered and so a perfectly valid liquidated damage provision. The use in argument of unlikely illustrations should therefore not assist a party to defeat a provision as to liquidated damages.”  [Philips v AG Hong Kong]
  • what the parties have agreed should normally be upheld. Any other approach will lead to undesirable uncertainty in commercial contact.”
  • “Both parties had the benefit of expert representation in the conclusion of the contract. The terms, including the liquidated damages clause, were freely entered into… in a commercial contract of this kind, what the parties have agreed should normally be upheld.” [Azimut-Benetti v Healey]
  • The court “recognises the utility of liquidated damages clauses and that to hold them to be penal is an interference with freedom of contract. It is, therefore, predisposed to uphold clauses which fix the damages for breach.” [Makdessi v Cavendish, Court of Appeal]
  • A pre-estimate does not have to be right to be reasonable.” [Makdessi v Cavendish, Court of Appeal]
  • “The true test is whether the [level of LADs] imposes a detriment on the contract-breaker out of all proportion to any legitimate interest of the innocent party…” [Makdessi v Cavendish, Supreme Court]

What should you do?

The only basis on which you can claim that the delay damages are a penalty and therefore unenforceable is if they are ‘extravagant and unconscionable comapred to the greatest loss that the innocent party may suffer arising from your breach‘. Check the level carefully BEFORE you sign.

For a summary of the law on penalties, the cases discussed above and the current law, see Cavendish Square Holding BV v Talal El Makdessi (Rev 3) [2015] UKSC 67

[Updated July 2018]

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