In the first of a new series, we look at a ruling that shows how difficult it is to overturn reasonable liquidated damages agreed in a contract
Tilebox engaged McAlpine as the main contractor on a commercial development in Guildford. The development consisted of stripping the building to its core and creating an international headquarters office building of 90,000ft2. Tilebox obtained funding for the development through an agreement by which Tilebox surrendered its leasehold interest in the building in exchange for £10m and a commitment by the funder to fund development costs up to a maximum amount.
Tilebox proposed liquidated damages of £45,000 per week, “representing the minimum weekly rental value of the completed development”. McAlpine initially resisted the figure on the basis that it was too high but eventually accepted it in the course of negotiations. A JCT design and build contract was signed in April 2001 with liquidated damages of £45,000 per week.
When the works were delayed by more than two years (and realising it was responsible to Tilebox for most of that delay), McAlpine, having taken legal advice, claimed that the liquidated damages clause was a penalty and, therefore, invalid. Tilebox rejected this claim and intimated that they could claim liquidated damages of £5.4m. McAlpine applied to court for a declaration that the liquidated damages provision was unenforceable as a penalty.
The judge (Mr Justice Jackson) considered these key issues:
- the obligations Tilebox had under its funding agreement to complete the development by (a) a specific date and (b) the completion date in the JCT contract
- which losses flowing from any delay were foreseeable when the JCT contract was signed
- having regard to the other issues, was the liquidated damages clause in the JCT contract unenforceable as a penalty.
The judge found that:
- although Tilebox had no obligation to complete by a specific date, it had to secure completion by the date set out in the building contract
- Tilebox’s foreseeable losses comprised (a) a reduction in a completion payment it was to receive from its funder (b) its liability to its funder and (c) its own direct losses
- based on its obligations and foreseeable losses, the figure for liquidated damages was “an entirely reasonable pre-estimate of damages”.
In refusing the application, the judge said that there had to be a substantial discrepancy between the level of damages stipulated in the contract and the level of damages likely to be suffered before it can be argued that the pre-estimate was unreasonable.
The judge identified five reasons for reaching his decision:
- the figure of £45,000 was “at or slightly above the top of the range of possible weekly losses flowing from the delay” and the gap between it and an appropriate yardstick “was not nearly wide enough to warranty characterising this clause as a penalty”;
- that using a conservative estimate of rental value as a yardstick had been “a genuine attempt to estimate the losses which would flow from future delay”;
- the difficulty in estimating future losses made it “particularly sensible for the parties to have agreed upon a weekly figure” in respect of the damages;
- the High Court (following the lead set by the Appeal Courts) is “predisposed where possible to uphold contractual terms which fix the level of damages” particularly in this case which related to “a commercial contract made between two parties of comparable bargaining power”;
- the fact that the liquidated damages figure had survived scrutiny by the parties and their legal advisers was “further evidence that […] the liquidated damages provision was reasonable”.
The judge also noted that there had been only four instances in previous cases that were put before him in the application where liquidated damages provisions had been struck down as a penalty and in each of those cases there had been a “wide gulf” between the damages likely to be suffered and those stipulated.
This decision has been followed recently in Azimut-Benetti Spa (Benetti Division) vs Healey (2010) where the court again showed a willingness to uphold liquidated damage clauses that have been negotiated between parties of equal bargaining power.
This judgment underlines just how important it is for a party in a contract with a liquidated damages clause to agree what, for that party, is the right level of damages for that particular contract at the time the contract is signed. There is little prospect of overturning what has been agreed except in exceptional of circumstances.
Michael Conroy Harris is a construction specialist at Eversheds