ACLN - Issue # 59 27
Delay
Liquidated Damages - Friend or Foe?
Even though liquidated damages clauses are • whether the clause provides for a single sum
commonly found in construction and engineering to be paid in the event of a number of different
contracts, there appear to be several fundamental breaches. Where the same amount of
misconceptions about such damages and how they work. liquidated damages is prescribed for different
By agreeing liquidated damages, the parties agree breaches which would, on their fact, give rise
at the outset the quantum of - or rate at which - damages to different levels of damage, the clause is
will be payable upon the happening of an identified more likely to be considered a penalty;
occurrence. The occurrence triggering the application of • the Court will also look at how the liquidated
liquidated damages must be one which would normally damages are expressed. A provision which
cause damage to the party in whose favour the liquidated calls for payment of damages as a percentage
damages apply. of the contract sum is more likely to be held
The classic application of liquidated damages is for as a penalty than liquidated damages which
late completion of contract works where liquidated are expressed at a dollar rate for a period.
damages are expressed to be at a stipulated rate per day or The damage to be suffered as the result of a
per week. If the specified event, such as late completion, particular breach does not necessarily bear
occurs and liquidated damages become applicable, it is any relevance to the contract sum and,
irrelevant whether any damage is actually suffered by the accordingly, liquidated damages expressed as
party entitled to liquidated damages. Similarly, it is a percentage of some unrelated figure are
irrelevant that the damage actually suffered by the "entitled more likely to be seen as a penalty.
party" is far in excess of, or less than, the liquidated
damages stipulated in the contract. Liquidated damages are also often seen by
At law, penalties in contracts in any form are contractors as being inserted for the benefit of principals.
unenforceable. Accordingly, a liquidated damages clause Although this is generally the case, liquidated damages
in a contract, if it is held to be a penalty, is unenforceable. can work for the benefit of contractors. The reason for
A provision for the payment of a sum of money by a party this is that liquidated damages operate effectively as a
in the event of its breaching a contract - where the purpose ceiling for the damages for which a contractor can be found
of the provision is not to compensate the innocent party liable. In some circumstances it may be that the actual
for its loss but to force the offending party to perform its damage suffered by a principal exceeds the liquidated
obligations under the contract - is a penalty. damages. Obviously, if that is the case, the contractor is
The test applied by the courts in determining better off with the liquidated damages provision which at
whether a clause is an acceptable liquidated damages least limits the damage to which it may be liable.
clause, as distinct from a penalty (except where public In summary, the important factors which are quite
purpose of "representative" contracts are involved), is to often misunderstood in relation to liquidated damages are:
determine whether the liquidated damages represent a • To be enforceable, the liquidated damages
genuine pre-estimate of the damage that is likely to be must be a genuine pre-estimate of the damage
suffered if the event occurs. likely to be suffered and not a penalty.
Ultimately, it does not matter whether the pre- • It is not necessary to establish any actual loss
estimate of likely damages turns out to be incorrect. The or damage for liquidated damages to be
courts have, in various cases, referred to a number of payable. The entitlement arises upon the
factors or principles in determining whether a clause is a occurrence of the triggering event.
penalty or a genuine pre-estimate of the loss likely to be • Liquidated damages represent both the floor
suffered. Some of these factors are: and the ceiling to the level of damages.
• the name which the parties have given to the
payment, although this is only indicative and - Reprinted with permission from
not conclusive; Clayton Utz's Construction Issues.
• whether the sum to be paid is extravagant
and unconscionable in comparison to the
greatest conceivable loss that could be
anticipated at the time the contract is entered
into;
