After Makdessi and GPP, the question is, are your LDs commercially viable?

Liquidated damages (LD) clauses are a fixture of construction contracts. As we all know, they are a secondary obligations to pay an agreed sum of money, arising upon breach of a primary obligation of the contract. In the case of a construction contract, this will invariably be in the event of delay: the failure to complete the works by a specified date.

LD clauses are the paradigm of something agreed very much in the hope that it will never be needed, when in the rosy glow of the start of a project, everyone is confident it will be completed on time. As a consequence, it may be that parties negotiating the sum don’t necessarily give it as much thought as they later feel it deserves when a project is overrunning, and the LDs are racking up.

However, the recent judgment of Mr Richard Salter QC in GPP Big Field LLP and another v Solar EPC Solutions SL (formerly known as Prosolia Siglio XXI) has confirmed, following on from Makdessi v Cavendish Square, that a genuine pre-estimate of loss does not need to be negotiated in minute (or indeed any particular) detail in order to avoid being seen as an unenforceable penalty.

GPP Big Field LLP v Solar EPC Solutions SL

The particular issue raised by the defendant in Solar was that the LDs clause (which was the same across several contracts), did not represent the extent of the loss the claimant was likely to suffer where there was a delay to commissioning of the relevant works. It was said that the extent of loss would be dependent upon the output of the plant and the prevailing electricity price. However, each of the EPC contracts provided for the same penalty of £500 per day per MWp, even though each of the plants had a different output, and there was a difference of over 30% in the expected electricity prices recorded in the various contracts.

It was also said that part of what weighed in favour of the court identifying the clauses as penalties was the fact that there had been, on the defendant’s case, no detailed negotiations to ascertain the appropriate level of LDs. The parties were in dispute as to the scope and nature of any such discussions.

However, ultimately, the judge found there probably had been no such detailed negotiations but it did not matter because, in summary:

• The clause was negotiated between commercial entities at arms’ length, and they were well able to “assess the commercial implications” of the clause.
• The fact that a round figure had been used, that might not match up to the actual loss incurred in any circumstance, was common across the construction industry.
• Any slight discrepancy that might arise between actual loss and the LD sum did not matter (following Cavendish):

“… provided that it is not extravagant and unconscionable in amount in comparison with the greatest loss that might have been expected when the contract was the contract was made to be likely to follow from the breach.”

Is the clause commercially justified?

Therefore, the judge has continued the line of thinking from Cavendish that the legitimacy of an LDs clause is not just about compensation but is also concerned with whether the clause can be commercially justified. As was explained in Cavendish:

“… compensation is not necessarily the only legitimate interest that the innocent party may have in the performance of the default’s primary obligations.”

Rather, a damages clause may properly be justified by some other consideration than the desire to recover compensation for a breach.

Therefore, the lesson to draw is not to get too caught up in the pounds and pence of the LDs figure. The bigger question is whether the sum can be commercially justified.

As the courts have said going back to Dunlop Pneumatic Tyre Co v New Garage Motor Co, in the case of a simple LDs clause (which will be the type included in most construction contracts), the notion of a “genuine pre-estimate of loss” is one test in the bigger armoury to help in ascertaining whether a clause is a penalty. However, the crux is going to be whether the sum agreed is out of all proportion to the greatest loss likely to be suffered.

As with all other clauses, the court’s job is not to get the parties out of a bad bargain. The parties will be fixed with the sum agreed, even if it is painful when the LDs kick in.

This article was first published on Practical Law’s Construction Blog.