Liquidated Damages Clause and Its Validity - Coursework Example

Construction Law Name Class Unit Introduction In any construction project, commencement and substantial completion are the most important phases. For a construction project, the set time for performance is measured when the contract commence or specific date for the completion of the whole project. Liquidated damages clause is imposed by the owner in the event the contractor fails to honour the completion dates specified on the contract (Yates and Epstein, 2006). Based on the law, the liquidated damages are supposed to be assessed based on the approximate actual losses the owner or the contractors incur if the project was not finished in the set due date. Despite this, it is possible in most instances for the damages assessed to have little resemblance to the losses incurred but are often like a financial hammer used to ensure there is timely performance (Davenport, 2006). This essay explains the liquidated damages clause, its validity and accesses the benefits and disadvantages to the employer and contractor for having this clause in their construction contract. Liquidated damages claim Most of the public and private contracts in construction industry contain the liquidity damages clauses. This is due to fact that in case of a delay, the project owner can be harmed by the added costs and lost revenue (Eggleston, 2009). The contract is used to ensure that there is no unnecessary delay as well as delay related litigation through use of this clause in their contracts. The clause imposes a dollar based assessment of every day delayed by the contractor. This assessment continues until the completion of the project by the contractor. This is well explained in a case Dunlop Pnumatic Tyre Company Vs. New Garage and motor Company. This is where the two companies signed an agency contract between them where DNT was the principle and NGM agent. Based on the contract terms, NGM was supposed to sell the goods below the listed prices. NGM was required to pay five pounds for every unit sold. The breach occurred when two of the items were sold below the specified prices. The court arranged for a compensation for 10 pounds as determined by the contract (Chetwin, M., 2011). Types of liquidated damages clause Breach of contract This occurs when the contractor fails to honour the contract. The clause must be present in the contract to make it a valid liquidated damages claim (Davenport, 2006). Failure to complete This is the most common of liquidated damages in the construction industry. The damages in this case are listed using the standard forms. There is also critical delay beyond which the damages change (Davenport, 2006). Validity of the liquidated damages claim In most standardised documents, having the liquidated damages claim is optional. Despite this, the provision is widely used in general and subcontractors to ensure that there is compliance with the deadlines. The use of liquidated damages claim is a well-defined test (Cushman, Cushman, Carter, Gorman and Coppi, 2000). The use of the clause helps in making sure the work is performed beyond the set milestones and completion dates set. The potential losses can be calculated in well-established procedure. This is especially if there is a liquidated damages provision in a construction contract (Eggleston, 2009). In some cases, it is common for the parties to challenge the validity of the damages provision when faced with a claim (Fawzy, El-adaway and Hamed, 2015). To challenge the validity of claim, the liquidated party must prove the following issues. The amount in the anticipated damages was easily ascertainable when the contract was formed. During the formation of the contract, the liquidated damages amount was not proportionate to the anticipated damages which would have been incurred in case of a breach. For the clause to be valid, both parties must have intended to liquidate their damages in advance. There is need to have clear and specific clause. The contract must be clear so that both parties make a clear and concise decision (Iyer, Chaphalkar and Joshi, 2008). Lastly, liquidated damages provision should have an amount which is a reasonable approximation of the losses incurred due to the delays. When a liquidated damages provision has no semblance to the actual delay damages that would have been anticipated during signing, it is deemed unenforceable. Hefty penalties for delays may lead to the contract being deemed unreasonable. There is a need to look at both anticipated loss and the actual loss as a result of the project not meeting the deadline. The aggrieved party should not be awarded more than the actual damages suffered test (Cushman et al., 2000). It is important to note that the liquidated damages are negotiable. Not easily ascertainable This occurs when the actual damages anticipated could not be calculated when the contract was enforced. This has led to the courts determining whether the damages were easily ascertainable during the signing of the contract (Fawzy, El-adaway and Hamed, 2015). Reasonable relationship The courts freely enforce contracts which are entered by sophiscated parties. Despite this, they draw a line on where the damages liquidated are unreasonable based on the nature of harm. Contracts which are deemed void based on the public policy are deemed enforceable irrespective of how freely or willingly they were entered (Iyer, Chaphalkar and Joshi, 2008). Difference between liquidated damages and general damages Damages and liquidated damages are both legal terms used when signing the contracts. Damages can be explained as the sum of money mentioned in the contract where the victim is expected to pay in case they breach their contract. A liquidated damage on the other case is invoked when the ability to ascend to the actual damages is difficult (Iyer, Chaphalkar and Joshi, 2008). The liquidated damages are seen as a fair way of paying the party which has been on the receiving end and are not punitive in nature. Damages are used mostly to compensate the victims in cases where there is no mention of the value in the contract. Liquidated damages are agreed upon entering the contract and paid to the party whose contract has been breached. Unlike the general damages, liquidated damages can be difficult to prove the actual harm or loss caused by the damage (Halpin, 2010). This makes the liquidated damages to be based on estimate of the actual damages that the breach would cause. General damages are only used to compensate form the direct loss suffered. Unlike the general damages, liquidated damages may be seen as unenforceable if the parties made no attempt in calculating the actual damages that can occur due to the breach (Yates and Epstein, 2006). Delay issue Most of the sophiscated contracts in construction industry have a provision for the risk of delay due to different issues. The use of liquidated damages clause in the project is a management tool to mortgage and plan in case of a delay. The issue of delay in the construction project is debated through various stages. This includes the pretender stage, negotiation and during the construction of the project. During the pretender stage and negotiations between parties there is assessment for the damages due to delays. Once the original date for the completion of the project elapses, the application of the delay damages occurs (Cushman, 2004). This leads to both practical and legal issues which have to be considered before asking for liquidated damages (Iyer, Chaphalkar and Joshi, 2008). Most of the projects experience delays hence exceeding time and costs estimated. The extensive delays can lead to costly claims and disputes. In some cases, delay in the construction industry is inevitable and costly. If not tackled delays in construction industry acts as a destructive factor in the industry (Scott, 1997). The main causes of delays in construction projects are attributed to: Design- this includes the change of the initial project design and complexity Construction related- this is caused by the variations and claims and changing project scope. Financial- this is based on the owners’ financial ability and lack of enough funds. Management-this is a delay caused by lack of suitable management team, unspecialised subcontractors, poor project management and lack of experienced consultant in the project. Regulations- this occurs when there is change in regulations and codes in the industry. Owners impose the liquidated damages when the cause of delay is the contractor fault. Despite this, the contractors may impose allegations of concurrent delays (Ibbs, Nguyen and Simonian, 2010). This is where the contractor argues that some of the delays have been caused by the owner or external forces. Since the owners submit the liquidated damages at the end of the project, the contractor claim cannot be submitted until they finish the project (Hinze, 2011). Use of concurrent delay helps the contractor to gain time extension and remission of the liquidated damages (Ibbs, Nguyen and Simonian, 2010). An excusable delay is one which cannot be attributed to the contractors’ actions or inaction. When approved, the contractor is held harmless and the owner cannot access the damages for the excusable delay (Eggleston, 2009). It is important to ascertain whether the damages level are genuine pre estimate loss. This is assessed during the time a contract is entered into. The case of Unaoil Ltd v Leighton Offshore Pte Ltd sought to seek the validity of the Liquidated damages clause since it was not considered after the contract was varied. This case was in 2010 and involved a contract between Leighton and Unaoil where it was agreed that Unaoil was to act as a subcontractor. The court found that Leighton made a breach to the memorandum of understanding (MOA) but it also rejected the Unaoil claim for LD. In making this decision, the court argued that the liquidated damages are accessed from the date a contract is entered into. The court could only accept liquidated damages clause based on the original MOA date based on genuine pre estimate losses and since this was no longer the case it was impossible. This is due to a reduction in the subcontract sum. The liquidated damages became unenforceable and hence the Unaoil’s claim was rejected. Unaoil was only awarded damages for the loss or profit they could prove that they suffered following the cancellation of the formal subcontract (Yates and Epstein, 2006). Benefits of liquidated damages claim for contractors and employers Liquidated damages are determined when drawing the contract and acts as a protection for both parties in the contract (Hinze, 2011). The use of liquidated damages clause in the construction industry leads to predictability of costs where parties are able to balance between the anticipated performance and the costs of the breach. This acts as a source for limited insurance for the both parties involved. Another advantage is the fact that the parties are given a chance to settle on a payment that is mutually agreeable. This is better than leaving those decisions to courts which would add costs of time and fees to lawyers (Williams, 2003). Use of the liquidated damages contract helps in preventing exploitation of the owner by the contractor. The contract also helps in making the breach efficient in case it occurs. This implies that no party is left worse off after the breach. It is important to note that a liquidated damages claim cannot be enforceable if it is punitive. This is due to fact that liquidated damages are used to attempt in quantifying loss in advance (Zaghloul and Hartman, 2003). Theoretically, a contract that is seen to penalise one party in unfair manner is problematic due to unconscionability. Other benefits include providing the contractual certainty, not requiring proof of loss, simplifies the disputes, inducing performance and providing a cap on the liability (Fawzy, El-adaway and Hamed, 2015). The liquidated damages clause must be well designed to ensure that the enforceable benefits are not lost. The liquidated damages act as genuine pre-estimate of the damages unlike the penalties which are a threat meant to put pressure on performance. Through use of liquidated damages clause, the contractor cannot be charged unfairly (Schwartzkopf and McNamara, 2000). If the owner is responsible for the failure of the contractor to finish the project on time, they cannot be compensated and the liquidated damages become invalidated. An example is the case in the English court of appeal Peak Construction (Liverpool) Pty Ltd v. McKinney Foundation Ltd where it was ruled that building owner was at fault for failing to give possession of the site in due time (Fawzy, El-adaway and Hamed, 2015). Liquidated damages help a lot in reducing the risks of legal errors and the probability of the judge erring in the judgment is highly eliminated. Through use of liquidated damages clause, it becomes possible to avoid some of the adverse problems. Liquidated damages helps in creating incentives for optimal reliance and precaution. The clause creates high level of responsibility. This makes both parties to ensure that they follow the laid down rules and procedures in the contract (Iyer, Chaphalkar and Joshi, 2008). A liquidated damage clause has all the information on the loss. The information is very critical for the owner as they can decide whether the breach of contract is efficient or not (Williams, 2003). The information is provided in advance which makes it possible for the owner to come up with efficient decisions. The information also leads to optimal prevention costs level (Yates and Epstein, 2006). Disadvantages of liquidated damages claims for contractors and employers The damages are calculated before commencing on the job and make it impossible for the judges to compute them after breach (Thomas and Wright, 2011). Thus, it becomes hard for the judges to compute the true loss. There is also a risk of the judge applying the liquidated damages clause wrongly (Harris and Scott, 2001). The use of liquidated damages clause leads to an increase in the final transaction costs. Estimating the ex-ante is costly than ex post. The ex-ante damages are based on estimations even in situations where no loss occurred. This implies that all states have to be taken into considerations unlike in ex post where there is more information. This makes the costs of ex ante information high since it is based on unknown (Yates and Epstein, 2006). Liquidated damages clauses are aimed at helping to compensate the owner. Despite this, they are set prior to the occurrence based on estimated costs. At the time of setting the costs, full information may not be available. When the compensation is lower than the damages, issues related to incentives arises. If the compensation exceeds the actual loss, the owners have an incentive to head due to an inefficient breach of contract (Zaghloul and Hartman, 2003). This leads to cases where the owner is over insured. For the employer, they cannot claim more money that what is stated in the liquidated damages claim. This is especially when the losses are greater than what is recoverable under the drafted contract. This can be explained by the case of Cellulose Acetate Silk Co Ltd v Widnes Foundry (1925) Ltd [1933] (Fawzy, El-adaway and Hamed, 2015). Conclusion To sum up, the essay has been able to explain the liquidated damages clause, and accessed its validity. The benefits and disadvantages to the clause of employer and contractor have also been discussed. For the clause to be valid, both contractor and owner must prove that the amount in the anticipated damages was easily ascertainable when the contract was formed. They must also prove that during the formation of the contract, the liquidated damages amount was not proportionate to the anticipated damages which would have been incurred in case of a breach. The damages are supposed to be liquidated in advance. The amount in damages must be reasonable for the clause to maintain validity. When not well handled, delays lead to high loss for both parties. Major causes of delays are; Design change, construction related issues, financial, management and changes in regulations and codes. The most important benefits for liquidated damages clause are; contractual certainty, not requiring proof of loss, simplifies the disputes, reduce loss, inducing performance and providing a cap on the liability. The main disadvantage is the fact that damages are calculated before commencing on the job and makes it impossible for the judges to compute them after breach. The information used is set prior to occurrence when some of the information might not be available. It may also leads to the owners being over insured. References Chetwin, M., 2011. Comparative analysis of some aspects of assessment of damages for contractual breaches in England and Wales, Australia and New Zealand. International Journal of Law in the Built Environment, 3(2), pp.113-125. Cushman, R.F., 2004. Construction business handbook. b Aspen Publishers. Cushman, R.F., Cushman, E., Carter, J.D., Gorman, P.J. and Coppi, D.F., 2000. Proving and pricing construction claims. Aspen Publishers Online. Davenport, P., 2006. Construction claims. Federation Press. Eggleston, B., 2009. Liquidated damages and extensions of time: in construction contracts. John Wiley & Sons. Fawzy, S.A., El-adaway, I.H. and Hamed, T.H., 2015. Contracting in a Global World: Application of the “Time at Large” Principle. Journal of Legal Affairs and Dispute Resolution in Engineering and Construction, p.04515001. Halpin, D.W., 2010. Construction management. John Wiley & Sons. Harris, R.A. and Scott, S., 2001. UK practice in dealing with claims for delay. Engineering Construction and Architectural Management, 8(5‐6), pp.317-324. Harris, R.A. and Scott, S., 2001. UK practice in dealing with claims for delay. Engineering Construction and Architectural Management, 8(5‐6), pp.317-324. Hinze, J.W., 2011. Construction planning and scheduling. Pearson Higher Ed. Ibbs, W., Nguyen, L.D. and Simonian, L., 2010. Concurrent delays and apportionment of damages. Journal of Construction Engineering and Management, 137(2), pp.119-126. Iyer, K.C., Chaphalkar, N.B. and Joshi, G.A., 2008. Understanding time delay disputes in construction contracts. International Journal of Project Management, 26(2), pp.174-184. Lim, T., 2012. Essence of Time in Construction Contracts. Construction Economics and Building, 9(2), pp.1-6. Schwartzkopf, W. and McNamara, J.J., 2000. Calculating construction damages. Aspen Publishers Online. Scott, S., 1997. Delay claims in UK contracts. Journal of construction engineering and management, 123(3), pp.238-244. Thomas, R.W. and Wright, M., 2011. Construction contract claims. Palgrave Macmillan. Williams, T., 2003. Assessing extension of time delays on major projects. International Journal of Project Management, 21(1), pp.19-26. Yates, J.K. and Epstein, A., 2006. Avoiding and minimizing construction delay claim disputes in relational contracting. Journal of Professional Issues in Engineering Education and Practice. Zaghloul, R. and Hartman, F., 2003. Construction contracts: the cost of mistrust. International Journal of Project Management, 21(6), pp.419-424. Read More