CONSTRUCTION Alert: A dollar a day keeps general damages away

Mar 28 2017

Publications

Often builders treat liquidated damages with suspicion in contract negotiations.  It is correct to say that liquidated damages protect owners in the sense that owners do not have to prove their actual loss by reason of builder delay.  Provided that the amount of liquidated damages represents an owner’s genuine pre-estimate as at the date of contract of the loss that it may suffer in the event of late completion, it does not matter that the rate of liquidated damages does not represent actual loss, is nowhere near actual loss or there has been no actual loss suffered at all by reason of the delay.

The purpose of this update is to emphasise that builders should not be so wary and sceptical about liquidated damages.  A properly drafted liquidated damages clause can actually protect builders from unknown loss and exposure that may result from the late completion of a project.  We also consider mistakes that parties make in amending and inserting liquidated damages clauses into contracts and offer some useful tips that builders may adopt to protect their interests when dealing with delay and their exposure on a project.

Liquidated damages clauses generally

Generally speaking, provided that the specified rate or amount of liquidated damages is a genuine pre-estimate of the loss that the owner is likely to suffer due to the builder’s default (and not so extravagant or unconscionable as to be construed as a penalty), the rate or amount will be recoverable by the owner upon demand.

Importantly, the owner does not need to show that it suffered actual loss, but only that the estimate was reasonable as at the date of contracting.  Further, it is irrelevant that any actual loss suffered by the owner is greater or less than the rate or amount stipulated in the liquidated damages clause (see J-Corp Pty Ltd v Mladenis [2009] WASCA 157 at [35]).

Of course, it is in the builder’s interests to attempt to negotiate the nominated rate or amount down so as to reduce its potential liability to the owner.

Importance of an effective liquidated damages clause

One of the key advantages of a liquidated damages clause is that it gives both parties a degree of certainty as to their respective rights and liabilities in the event of late completion.  This offers obvious benefits to both the owner and the builder.  The owner does not need to prove the actual loss suffered and the builder’s liability is limited to the specified amount.

There are potential downsides though.  Take for example the situation where the owner’s actual loss turns out to be substantially greater than the amount stipulated in the liquidated damages clause.  The owner will then find itself in a situation where it is limited to the specified amount and will bear the brunt of the additional loss (or otherwise will take steps to mitigate, such as giving a direction to accelerate).  This is the true benefit to the builder and why, if the parties agree that there are to be damages for builder delay, the prudent option is for liquidated damages to be included in a contract.

Another way in which a liquidated damages clause can actually benefit the builder is that in the absence of an effective liquidated damages clause, the owner may seek to recover common law general damages (which could be substantially greater than the amount stipulated in the liquidated damages clause).  In that situation, the builder is faced with an unknown exposure to common law general damages.

Below are some important considerations that builders should carefully note when dealing with liquidated damages clauses at the contract-formation stage.

Caution around the rate or amount specified – ‘$nil’ or ‘N/A’

If the parties intend for there to be no damages payable to the owner if the project runs over time, how should the parties reflect this in the contract?  Should the parties just delete the liquidated damages clause altogether?

Some parties amend a liquidated damages clause to specify that the liquidated damages payable upon breach will be ‘$nil’ or ‘zero dollars’.  Other contracts are amended to state simply that a liquidated damages clause is ‘N/A’ or ‘not applicable’.

Often these particulars are inserted in an attempt to reflect an agreement between the parties that there be no damages payable to the owner in the event that a project runs over time.  However, we also see this happening in contracts where the builder has been given the first shot at completing the contract particulars, as the perception is that the builder is effectively eliminating its potential liability.

It is important for builders to be aware that particulars like these leave it open for owners to claim that liquidated damages do not apply and consequently, the owner is entitled to recover common law general damages reflecting the owner’s actual loss.

There has been a string of cases in Australia and the UK that have attempted to deal with the question of whether a liquidated damages clause will be an exhaustive remedy (i.e. does it exclude the ability to recover general damages) even where the amount of liquidated damages is not expressed as a positive amount. The approaches of the courts in Australia and the UK differ significantly.  The view of the English courts seems to be that a liquidated damages clause will be construed as an exhaustive remedy even if it is expressed to be $nil or N/A (see for example Temloc Ltd v Errill Properties Ltd (1998) 39 BLR 30).

The Australian courts have emphasised that clear words are required to be used where the parties intend to abandon the right to recover common law remedies.  The position in Australia is that the words ‘$nil’, ‘zero’ or ‘N/A’ in a liquidated damages clause simply will not cut it and clear words are needed to prohibit an owner recovering common law damages for delay (see for example J-Corp Pty Ltd v Mladenis [2009] WASCA 157; Baese Pty Ltd v RA Bracken Building Pty Ltd (1990) 6 BCL 137; Silent Vector Pty Limited v Squarcini [2008] WASC 246).

Solution: understated liquidated damages clause?

Generally speaking, what can be adduced from the case law is that a valid and mandatory liquidated damages clause in a building contract which stipulates a positive amount of liquidated damages for failure to achieve practical completion by the due date will usually be evidence of an intention by the parties to exclude the right to recover common law damages.   Further, and as outlined above, it is well established that an owner cannot simply ignore a liquidated damages clause and claim general damages if the owner’s actual loss ends up being greater than the amount specified in the liquidated damages clause.

Does this mean then that parties can agree to be bound by an extremely low rate for liquidated damages, say for example, $1 per day?  The answer to this question seems to be (at least for the moment) yes.

The case of Cellulose Acetate Silk Co Ltd v Widnes Foundry [1933] AC 20 is the leading authority on the issue and provides an example of how a particularly low liquidated damages rate can operate to effectively exclude general damages.  The liquidated damages clause in Cellulose stipulated that the builder would pay the owners a sum of £20 for every week that completion of the works was delayed.  The builder ended up being 30 weeks late.  The owners sought to circumvent the liquidated damages clause and recover general damages for their actual loss suffered as a result of the 30 week delay.  The owners actual loss was approximately £6,000, compared with the £600 recoverable under the liquidated damages clause, and on that basis the owners claimed that the liquidated damages clause was a penalty.  The House of Lords unanimously held that the sum of £20 per week was the full amount the builder agreed to pay to the owners for delay in completing the work and therefore the builder was liable to pay £600 and no more.

This line of thinking has been met with approval in Australia (see for example J-Corp Pty Ltd v Mladenis [2009] WASCA 157; Knott v Beechwood Homes (Home Building) [2012] NSWCTTT 393).

It is becoming increasingly common in residential building contracts and smaller commercial projects for the parties to agree that the builder is not to be liable for any of the owner’s loss by reason of builder’s delay.  Perhaps, therefore, an effective method for contracting parties to record an agreement that there be effectively no damages payable if the project runs over time is for the parties to retain a clear and mandatory liquidated damages clause and simply limit the amount of liquidated damages payable to a small sum (that is not $nil).  This is more likely to protect against the risk of general damages being recoverable.

Alternatively, a properly drafted exclusion clause should be inserted into the contract which clearly and unequivocally excludes the builders liability under the contract and at law for any damages resulting from the builder’s delay.

Conclusion

Whether expressed as $1 per day, $50 per day or $100 per week, understated liquidated damages clauses may be the key in effectively recording an intention that limited damages are paid to an owner if the project runs over time.  It is also useful to include a contractual term that the parties agree that the specified rate reflects the owner’s genuine pre-estimate of the loss likely to be suffered in the event of default.

When drafting or reviewing a liquidated damages clause, the parties should ensure that:

  • the liquidated damages clause clearly expresses the parties’ intention as to whether the right to recover common law general damages is excluded;
  • the liquidated damages clause is expressed in a positive amount (avoid the words ‘$nil’, ‘zero’ or ‘N/A’); and
  • if the parties intend for no damages to be payable to the owner and wish to avoid common law damages coming into play, the rate or amount of liquidated damages is specified as a low monetary amount or alternatively an effective exclusion clause is inserted.

So long as there is a clear and unambiguous intention to exclude common law damages, then the builder’s liability will be limited to the amount stipulated in the liquidated damages clause.  The owner will be unable to resort to common law damages, even if the owner’s actual loss far exceeds the amount of liquidated damages.  Further, the exposure to liquidated damages is known at entry to contract and can be effectively priced by the builder.  The builder can actively take mitigation measures to reduce delay in circumstances where it has a full appreciation of its exposure to delay.

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Andrew Kelly has been recognised in the 2017 Expert Guide to Construction and Real Estate in Australia, one of only three Queensland based construction lawyers to be recognised.

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For further information please contact:

Andrew Kelly | Partner | +61 7 3338 7550 | akelly@tglaw.com.au
Christopher Collins | Senior Associate | +61 7 3338 7553 | ccollins@tglaw.com.au
Isabelle Scanlan | Lawyer | +61 7 3338 7934 | iscanlan@tglaw.com.au