Construction delays: liquidated damages and penalty clauses revisited

The recent case of Eco World – Ballymore Embassy Gardens Co Ltd v Dobler UK Ltd [2021] EWHV 2207 (TCC) considers:

• Whether or not a contractual right to claim liquidated damages for delay can amount to a penalty clause in circumstances where partial possession has been taken by the employer and;
• Whether or not liquidated damages clause can be construed as a limit to the contractor's liability in general damages, in the event it was deemed a penalty clause.

Eco World – Ballymore Embassy Gardens Co Ltd (Eco) entered into a JCT 2011 Construction Management Trade Contract with Dobler UK Limited (Dobler) to design, supply and install façade and glazing works at a development in London. The development was made up of three separate blocks of flats containing both private and affordable housing.

The Contractual completion date for the Works was 30 April 2018 (the Completion Date) but that date came and went. On 15 June 2018, Eco took possession of Blocks B & C but did not issue a practical completion certificate until the works in Block A were complete, on or around 18 December 2018.

Eco issued its provisional assessment of the contract sum that included a deduction for liquidated damages in the sum of £574,184.20, at a rate of "£25,000 per week up to an aggregate maximum of 7% of the final contract sum". Dobler rejected Eco's assessment of liquidated damages and issued a payless notice without a deduction for liquidated damages. Adjudication ensued.

The Adjudications

The first adjudication did not result in a decision.
In the second adjudication, the adjudicator decided that Eco was entitled to liquidated damages for delay beyond the Completion Date up to the date on which it took over part of the works (15 June 2018). As soon as Eco took possession of Blocks B & C, deemed practical completion occurred and liquidated damages could not be levied after that date.

In the third adjudication, the adjudicator decided that he was bound by the decision in adjudication 2.  He also decided that the Contract's liquidated damages provision  was not uncertain or unenforceable and it was an exhaustive remedy for delay which excluded Eco's claim for general damages.

The Court Proceedings

Dissatisfied with the adjudication outcomes Eco commenced court proceedings.  It now claimed (contrary to its position in the adjudications) that where an employer under a construction contract has (and exercises) a contractual right to take early possession in circumstances where the liquidated damages provisions do not provide for a reduction in the level of liquidated damages to reflect such early possession, those liquidated damages provisions must be void and/or unenforceable.  In their view such a provision must be construed as a penalty clause (Issue 1).

In the event the courts agreed with its analysis, Eco went on to claim that it was entitled to claim uncapped general damages from Dobler for the period of delay which would reflect its actual loss caused by the delay (Issue 2). 

Issue 1

In reaching her decision, O'Farrell J acknowledged that where a single sum is payable on the occurrence of either one or very many events, there is a presumption of that provision being penal in nature[1].  The logic is obvious.  A single lump sum may appear reasonable on the occurrence of very many events but out of all proportion to the level of loss that might flow from the occurrence of just one of those events. 

In the context of a building a single sum might be appear reasonable when a user is deprived of using it in its entirety but not when deprived of just one part of the building. Applying this presumption in this case would have rendered the liquidated damages clause void.  Instead, O'Farrell J, simply reaffirmed the principle that each provision must be considered in the context of the contract as a whole and objectively giving effect to the parties' intentions.

In doing so, O'Farrell J applied the test in Cavendish Square Holding BV v El Makdessi and ParkingEye Ltd v Beavis [2015] UKSC 67 to find that the "liquidated damages provision in this case is not unconscionable or extravagent so as to amount to a penalty" . Since Makdessi the Courts have removed the emphasis formerly placed on whether the liquidated damages amounted to a "genuine pre-estimate of loss".   It does not follow that a clause that does not amount to a genuine pre-estimate of loss, is necessarily penal in nature. O'Farrell J noted four relevant factors in deciding that the liquidated damages provision was not penal:
 

1. "The liquidated damages provision was negotiated by the parties, who both had the benefit of advice from external lawyers. The court should be cautious about any interference in the freedom of the parties to agree commercial terms and allocation of risk in their business dealings.

 

2. Eco had a legitimate interest in enforcing the primary obligation of Dobler to complete the Works as a whole by the Completion Date. Late completion of any part of the Works exposed Eco to either liquidated damaged under its contract with the Local Authority or loss of purchasers for the private apartments

 

3. Quantification of the damages that would be suffered by Eco would be difficult, particularly if part, but not all, of the Works were completed on time…By fixing in advance the liquidated damages payable for late completion of the whole Works, the parties avoided the difficulty of calculating and proving such loss.

 

4. Neither party had sought to claim that the liquidated damages provision in the Contract [a rate of £25,000 per work subject to a maximum of 7% of the contract sum] was extravagant, exorbitant or unconscionable".

Issue 2

Having decided that the liquidated damages provision was valid and enforceable, O'Farrell J did not have to consider Issue 2, but did so anyway. Dobler responded to claim that even if the liquidated damages provision was void, the wording of the Contract resulted in its liability for general damages being capped at "an aggregate maximum of 7% of the final Trade Contract Sum…"

O'Farrell J confirmed that the clause must be construed in accordance with the established principles of contractual interpretation. Upon literal interpretation, it would suggest that the 7% cap would apply only to the liquidated damages and not to any general damages. However, the objective understanding of the parties' intention would be that the provision served two purposes: 1) to provide for and quantify automatic liability for damages for delay and 2) to limit Dobler's overall liability for late completion to a specific percentage of the final contract sum.

Therefore, O'Farrell confirmed that even if Issue 1 was decided differently and in Eco's favour, Eco would still be entitled to claim general damages for delay but subject to the overall liability cap of 7% of the Contract Sum.

Discussion

Making out a penalty clause claim is always a difficult one and such difficulty has increased since Makdessi. Prior to the Makdessi case, one can see that the decision may well have gone a different way with a focus on whether the liquidated damages clause amounted to a genuine pre-estimate of loss.  Post Makdessi, the courts have shifted focus, and are more concerned with the liquidated damages provision being "proportionate to the legitimate interest of the Employer in the enforcement of the primary obligation of completion of the Works."
As ever, the need for contractual certainty and the parties' freedom to contract and allocate risk as they see fit is of upmost importance. Wishing to reinforce this importance may be the reason why the courts are interpreting liquidated damages clauses more positively and without the typical scepticism seen in the past.

Co-authored by Tyler Fitzpatrick, real estate and construction associate.