What are Liquidated Damages in England?

As a business dealing with construction contracts, you may come across liquidated damages. These clauses are widely used in the construction sector and serve as an effective risk management tool. 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. 

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What Are Liquidated Damages?

Liquidated damages are a type of contractual damages in English law. Most commonly found in the construction industry. A liquidated damages provision states that the contractor must pay the principal/developer a fee if it does not achieve ‘practical completion’ by the specified date in the contract. 

Liquidated damages are usually calculated based on the actual loss that will occur if the site is not handed over to the client on the specified date. This might include costs such as:

• rent for temporary accommodation;
• running costs;
• storage costs; and
• lost profits. This is often used for a commercial purpose.

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. The most common breach giving rise to liquidated damages is a failure to hand over the site to the principal by the practical completion date.

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 refers to this as general damages, but you may also hear it referred to as unliquidated damages. To obtain general damages, the innocent party must demonstrate that they have suffered a loss. You must also demonstrate that the contractual breach caused the loss.

Can I Always Enforce a Liquidated Damages Clause?

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

Generally, a term agreed upon between contracting parties in a business relationship is 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, where the amount is exorbitant or unconscionable in the context of the arrangement. Generally, the law will not recognise penalty clauses. 

It is important to note that the courts of England and Wales have evolved their approach to penalty clauses in recent years. While the traditional view focused solely on whether a clause represented a genuine pre-estimate of loss, the modern approach is more nuanced. The courts now consider whether the clause protects a legitimate business interest and whether the detriment imposed is disproportionate to that interest. This shift allows for a more flexible interpretation of liquidated damages clauses in complex commercial contracts. 

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

What if My Clause is a Penalty?

If your counterparty is in breach of the contract and you are seeking to enforce a liquidated damages clause that the counterparty believes is a penalty clause, the party may challenge the payment of this amount. If the court rules that the clause is a penalty clause, it will be ineffective and unenforceable. However, you may be able to claim damages along with the 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. It is a good idea to make a contract variation to reflect the likely loss you might suffer if the specified term is breached. It is also advisable to periodically review your liquidated damages clauses to ensure they remain proportionate and reflective of potential losses, particularly in long-term contracts. 

Key Takeaways

You may come across liquidated damages clauses as a business operating in the construction industry. A liquidated damages clause requires the party in breach to pay a specified amount of money to the innocent party, typically for failing to complete a construction project by the practical 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 a genuine pre-estimate of the likely loss you would suffer from a breach. If your clause is unenforceable, you may still be able to claim for general damages, though you will need to take your case to court to have general damages awarded and enforced.

If you need help with your business, our experienced construction and disputes lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today at 0808 196 8584 or visit our membership page.

Frequently Asked Questions

What are general damages?

General damages are a typical remedy in contract law and operate much like monetary compensation. For example, the innocent party are awarded compensation by the court for the losses.

What is a penalty?

A penalty is a contract term that seeks to punish the other party for a breach.