What are Liquidated Damages in England?

As a business dealing with construction contracts, you may come across liquidated damages. A liquidated damages clause is common in the construction industry and can be useful for managing risk within your business ventures. Ultimately, a liquidated damages provision will allow you to recover a predetermined amount of money in the event of a specific breach. This article will explain what a liquidated damages clause is, how it works, and how you can be sure that your clause does not amount to a penalty. 

What Are Liquidated Damages?

Liquidated damages are a type of contractual damages in English law, and they most often appear in the construction industry. A liquidated damages provision states that the contractor must pay the developer a fee if it does not achieve ‘practical completion’ by the date in the contract. 

Practical completion simply means the point at which the building site is completed and handed over to the client. Importantly, liquidated damages are usually calculated based on the actual loss that will occur if the site is not handed over to the client at the specified date. This might include costs such as:

• rent for temporary accommodation;
• running costs; and
• removal costs.

Why Use a Liquidated Damages Clause?

Including liquidated damages provisions within your contract can be helpful because it eliminates the need to take your case to court to determine the liability of a breaching party. In other words, the contract will clearly state the amount one person owes the other in the event of a breach.

If you do not have a liquidated damages clause and a dispute arises, you may need to take your case to court. There, a judge will determine the monetary value of the loss you have suffered. The law calls this general damages, but you may also hear it referred to as unliquidated damages. To obtain general damages, the innocent party must be able to show they have suffered a loss. You must also demonstrate that the contractual breach caused the loss.

This can be a time-consuming and expensive process, so having a liquidated damages clause can help you save the effort of taking your case to court. It can also help you manage risk in your contractual relationship, as you can set out the likely loss you will suffer for undelivered work or delays. 

Can I Always Enforce a Liquidated Damages Clause?

In some cases, a party might wish to argue that a liquidated damages clause is unenforceable. 

As a general rule, a term agreed to between contracting parties in a business relationship will be enforceable. A court will assume that a term is enforceable provided that the parties entered it freely. However, a liquidated damages clause will not be enforceable if a court determines that it amounts to a penalty.

Penalty Clauses 

The law describes a penalty clause as a term that intends to deter the other party from breaching the agreement. Generally, the law will not recognise penalty clauses. We define penalty clauses as any term that imposes a disproportionate obligation on the party in breach. 

This means that if your liquidated damages clause disproportionately punishes the contract-breaker, it may not be valid. Therefore, if you are considering including a liquidated damages provision within your agreement, ensure that you have a genuine pre-estimate of loss in the event of a breach.  If your clause is not a genuine estimate of the loss that you might suffer, it might be unenforceable altogether.

As an example, a clause that imposes a blanket ban of £2m for any delay whatsoever is likely to be a penalty clause. This is because it does not seek to apportion costs based on the cause of the breach. 

What if My Clause is a Penalty?

If your counterparty is in breach of the contract and it has a clause the counterparty believes is a penalty clause, the party will not pay. You will have to go to court and ask it to determine if the clause is a legitimate liquidated damages clause. If the court rules it is a penalty clause, the clause will be ineffective. The court will then assess damages along with general principles of recovery.  

Although it may not be difficult to prove loss, taking your case to court is always a time-consuming and expensive procedure. Therefore, if you are concerned that your clause might be unenforceable, it is a good idea to make a contract variation to reflect the likely loss you might suffer if the specified term is breached. 

Key Takeaways

You may come across liquidated damages clauses as a business operating in the construction industry and under English law. A liquidated damages clause requires the party in breach to pay a certain amount of money to the innocent party, usually for failure to complete a construction project by the completion date.

Liquidated damages clauses may be unenforceable if they amount to a penalty. As a result, you should ensure that your liquidated damages provisions are genuine pre-estimate for the likely loss you would suffer from a breach. If your clause is unenforceable, you will still have general damages available, though you will need to take your case to court to have general damages awarded and enforced.

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