When damages become an unenforceable penalty

It is common practice in main contracts to include a provision for the deduction of liquidated damages in the event of delay. The intention of such clauses is to pre-determine between the parties the sum payable by way of damages in the event of a delay in completion.

In contrast subcontracts rarely provide for liquidated damages in the event of delay by the subcontractor. The primary reason for this is straight-forward. An employer is in a relatively easy position to compute the level of damages which it is likely to suffer in the event of delay in completion of the project as a whole. The main contractor on the other hand cannot readily anticipate the damage it will suffer in the event of delay by a subcontractor, for that damage will come from a variety of sources dependent upon the nature, circumstances and timing of the delay.

suffered

The losses suffered by the main contractor may embrace damages imposed by the employer, direct costs incurred in providing its own additional resources, and claims from other subcontractors and suppliers. The courts have been ready to intervene to enforce liquidated damages provisions, recognising that there are benefits to both parties in making such provisions.

In Temlock -v- Errill in 1987, the Judge said "there is every reason why parties to building contracts should agree to liquidated damages for non-completion. Proof of such loss is often difficult to achieve and agreement in advance is a saver of disputes."

It has also long been recognised in the industry that the courts will not enforce the liquidated damages provision if the sum stipulated is found to be a penalty rather than a genuine pre-estimate of the loss.

In the 1915 case of Dunlop Pneumatic Tyre Company -v- New Garage Motor Company, the House of Lords set out the general principles in this regard. It was held that whether a provision would be treated as a penalty was a question to be judged as at the time of making the contract, not at the time of the breach.

As a matter of construction, it was not relevant how the provision was described in the contract, but it would be held to be a penalty "if the sum stipulated for is extravagant and unconscionable in amount in comparison with the greatest loss which could conceivably be proved to have followed from the breach".

In the 1966 case of Robophone Facilities -v- Blank it was determined that the onus of showing that the specified sum was a penalty, lies upon the party who is sued for its recovery. These matters were closely examined in the recent case between Ballast Wiltshier and Thomas Barnes on appeal against an arbitrator's award.

Ballast Wiltshier were main contractors on a project known as the Arcades, Ashton-under-Lyne, and had employed Thomas Barnes as subcontractors for certain reinforced concrete works.

The subcontract was in the form of a modified DOM/2 form, which in its standard format contains no provisions for liquidated damages, but at Clause 12.2 provides that after notice of failure to complete on time, "the subcontractor shall pay or allow to the contractor a sum equivalent to any direct loss and/or expense suffered or incurred by the contractor, and caused by the failure of the subcontractor."

In addition to this clause the parties had agreed a provision for liquidated and ascertained damages in a separate numbered document forming part of the agreement. This document identified three sections of the works and rates for liquidated and ascertained damages for each section were filled in.

counterclaim

These were precisely the same as the figures used in the main contract between Ballast Wiltshier and its client, although the sums appeared to apply to different areas. In its counterclaim Ballast Wiltshier alleged wrongful delay in completion of the subcontract works and claimed £1.96m as liquidated and ascertained damages, or alternatively £146,000 as general damages.

In his award the arbitrator recognised that the parties had freely negotiated these terms but nevertheless held that the figures inserted as liquidated damages were not reasonable estimates of the losses that might be suffered by the main contractor in the event of delay, and rejected the claim in its entirety.

On appeal, counsel for Ballast Wiltshier argued that it is often reasonable for a contractor to estimate that the damages likely to be suffered from breach of the subcontract by delay is the amount of damages payable by the contractor under the main contract.

It was also argued on Ballast Wiltshier's behalf that the arbitrator had mis-directed himself as to the burden of proof, in that he had apparently failed to consider that it was for Thomas Barnes to establish that the sums were a penalty. Counsel for Thomas Barnes submitted that this had made no difference. He asserted that the difference between the sums claimed for liquidated damages and general damages was startling.

Moreover he argued that the agreed damages could not have been a genuine pre-estimate of the loss, because not only were they the exact same in amount as the sums in the main contract, but also that they were in respect of different areas from the main contract.

Hearing all of this, His Honour Judge Bowsher QC dismissed the appeal, declining to disturb the arbitrator's award that the damages were unenforceable as a penalty.