The practical implication of this case is that LD provisions in construction contracts are likely to be enforceable unless the amount is extravagant, exorbitant or unconscionable.
The new liquidated damages test in the Makdessi / ParkingEye case came out in the UK in 2015. In the Makdessi / ParkingEye case, the court decided that it was not a penalty even though it is not a genuine pre-estimate of loss provided that (1) there is a legitimate business interest and (2) the stipulated sum is not completely out of proportion to the interest to be protected. However, both Makdessi and ParkingEye are not construction cases.
Recently, there was a construction case in the UK adopting the Makdessi / ParkingEye principle. In this case, the Contractor entered into different Engineering, Procurement and Construction (“EPC”) contracts relating to the construction of several solar power generation plants in the United Kingdom. The Contractor went into liquidation and therefore the Employer sued the parent company of the Contractor as the guarantor of the Contractor’s obligations under the EPC contracts. The claim is for damages for late and / or non-completion of the works pursuant to clause 21.5 the EPC contracts. The Defendant argued, amongst other things, that clause 21.5 is a penalty clause and so it is unenforceable in law.
The wording of the EPC contracts was based on the wording of contracts governed by Spanish law, which had been used in relation to earlier solar power projects in Spain. One of the judge’s comments is that the wording is more prolix and repetitive than the wording typically found in standard-form construction contracts governed by English law.
Clause 21.5 provides
“In the event of the delay of more than fifteen (15) calendar days for the date of the commissioning, the Contractor shall pay to the [Employer] a penalty, which shall be paid in the way that the amount of the penalty, as accrued up to the date of the next invoice of the Contractor to the [Employer], shall be deducted from said invoice. The amount of the penalty is hereby established as the amount of GBP500 per day per MWp installed and per day that the construction works suffer a delay (Delay Damages). Delays of fifteen (15) calendar days or less shall not generate any penalty, being the 15 calendar days understood as an integral grace period over the whole Calendar of Works, not for each event of fortuitous reasons or Event of Force Majeure. The maximum of the penalty for delays of the Works shall be two hundred and fifty thousand pounds sterling per MWp (GBP250,000/MWp).”
Obviously this is not a usual LD provision that we commonly use in the UK or Hong Kong and it is not easy to understand. The Defendant argued that the clause is worded as a penal provision, and the sum was not a genuine pre-estimate of loss because the extent of the loss likely to be suffered would be dependent upon the output of the plant and the prevailing electricity price but, each of the EPC contracts provides for the same penalty regardless of their different outputs and expected electricity prices.
The judge applied the Supreme Court decision in Makdessi / ParkingEye:
… The true test is whether the impugned provision is a secondary obligation which imposes a detriment on the contract-breaker out of all proportion to any legitimate interest of the innocent party in the enforcement of the primary obligation …
… What is necessary in each case is to consider, first, whether any (and if so what) legitimate business interest is served and protected by the clause, and, second, whether, assuming such an interest to exist, the provision made for the interest is nevertheless in the circumstances extravagant, exorbitant or unconscionable …
… I therefore conclude that the correct test for a penalty is whether the sum or remedy stipulated as a consequence of a breach of contract is exorbitant or unconscionable when regard is had to the innocent party’s interest in the performance of the contact …
The judge concluded that clause 21.5 is not a penalty clause because:
- delay damages provisions of this kind are common in construction contracts, and the parties were experienced and sophisticated commercial parties of equal bargaining power, who were well able to assess the commercial implications of clause 21.5.
- the sum is not in any way extravagant or unconscionable in comparison with the legitimate interest of the Employer in ensuring timely performance.
- liquidated damages clauses are often used in cases where precise prediction of the likely loss is difficult.
- the fact that the loss resulting from that breach may vary in amount depending on the actual circumstances does not of itself give rise to any inference that the sum agreed to be paid is a penalty.
- the parties also used the words “Delay Damages” to define the sum. The reference to the sum as a “penalty” is therefore an equivocal indication.
The practical implication of this case is that LD provisions in construction contracts are likely to be enforceable (even though it is not a genuine pre-estimate of the loss) unless the amount is extravagant, exorbitant or unconscionable. However, when drafting a construction contract, we should avoid using the word “penalty” in the LD provision although the label is not conclusive. Further, the Employer should try to assess the likely loss (keep the calculation sheet) and make sure that the LD amount is not completely out of proportion to the greatest loss that might have been expected due to late completion.