Legal eagle – Damage control
Liquidated damages are provisions in a contract that state how much in damages one party must pay the other if a certain default event happens. The aim is to remove the need for the party suffering loss to prove the damage he has suffered.
Liquidated damages are usually associated with delay, though the concept of liquidated damages can be applied to any non-performance of a contract. For instance, on turnkey contracts for process plants, one often finds ‘performance’ liquidated damages: these apply to a situation where the plant does not meet the performance specifications precisely.
The contractor may have the option of ‘buying down’ his performance by paying performance liquidated damages instead of going through repeated tests to try and meet the specifications.
However, here we are going to look at three key issues associated with liquidated damages for delay.
First, you may have heard people talk about liquidated damages provisions as being a ‘penalty’ and hence unenforceable.
In India, this is no longer an issue as Parliament has by legislation removed the distinction between enforceable liquidated damages clauses and those that are unenforceable as penalties. However, in most of the other common law jurisdictions this distinction remains. Essentially, if it can be shown that the level of liquidated damages are such that they could not have been a genuine pre-estimate of loss that could result from the default event, the clause can then be struck down a penalising clause (or penalty). But just because the liquidated damages clause is unenforceable does not mean that the defaulting party is relieved from having to compensate the other party for damages; all it means is that the party seeking damages has to prove how much loss he has suffered, and he can no longer rely on the figure identified as liquidated damages.
Secondly, it is often said that liquidated damages can be levied without the party suffering loss having to prove his loss. This is axiomatic. But an interesting issue arises where there may have been no loss suffered at all – as opposed to a situation where some loss has been suffered but it is difficult to quantify. In India, the ONGC v Saw Pipes case is often cited as support for the argument that since a party does not need to prove his damages, it should not matter whether or not he has suffered any loss.
Thirdly, check if the liquidated damages provision is stated to be the exclusive remedy for delay. As liquidated damages are usually capped (at 10% of the contract price), the contractor’s total liability for liquidated damages may be reached much before the works in delay are actually complete. There is probably not much basis for this fear as each additional day the contractor spends on site, it is spending money and, if it is already in delay, that money will not be recoverable. However, employers still like to threaten to terminate the contract after the limit of liquidated damages has been reached. If the contract says that the liquidated damages clause is the exclusive remedy for delay, the employer may not be able to terminate the contract for delay.
The amount of caselaw and writing on liquidated damages means that the principles surrounding liquidated damages clauses are now relatively settled and certain. However, slight amendments to such clauses, or the juxtaposition of ‘cut and paste’ clauses, can completely change the meaning and effect of the contract. Liquidated damages provisions are now commonplace but must still be treated with care.
• Shourav Lahiri is the principal at Lahiri LLC, a Singapore-based law firm specialising in construction and engineering law and arbitration. He can be reached at shourav.