Continuing our series on the basics of construction law, Chris Busaileh considers some of the issues with including liquidated damages clauses in subcontracts
Construction contracts commonly use liquidated and ascertained damages (LADs) clauses to set a predetermined rate of damages to be paid on the occurrence of certain breaches, most commonly delay. The commercial rationale is clear: LADs promote certainty and avoid the need for the innocent party to establish its actual losses as a result of the delay (which can often be costly and protracted).
There are a number of specific issues that need to be considered for a main contractor looking to include LADs clauses in subcontracts.
Setting the rate of LADs – out of pocket or a windfall?
At first view, it would seem that the safest way for a main contractor to protect itself against delay losses under the main contract would be to simply flow down the rate of main contract LADs to each of the subcontracts. It is not that straightforward, though.
Even if the subcontractors agreed to the same LADs rate as in the main contract (a big assumption), the main contractor may still not recover all its losses. The reason comes back to the concept of LADs being an exclusive remedy for delay, something touched on in a previous article in this series, on enforceability of LADs clauses. Where LADs clauses are included in construction contracts, they are typically drafted as being an exclusive remedy for delay. This essentially means that the party seeking to rely on the clause cannot recover any more than the stipulated rate. If a main contractor incurs greater delay-related losses than the rate of LADs, it will be out of pocket.
A main contractor could benefit financially from delay if it flows down the main contract LADs to all its subcontracts
For a main contractor, LADs under the main contract are not its only possible losses from delay. A subcontractor in delay may cause delay or disruption to other subcontractors, which may then seek to recover the resulting loss and expense from the main contractor. In addition, the main contractor is likely to incur its own costs from delay, such as extended preliminaries. If the main contractor is limited to recovery of the main contract LADs from the delaying subcontractor, it cannot recover any such additional losses.
On the other hand, a main contractor could benefit financially from delay if it flows down the main contract LADs to all its subcontracts. Firstly, a delay under a subcontract may cause no overall delay to the main contract works, and so the main contractor could recover LADs from a subcontractor when it has no liability to the employer.
Secondly, if there were a number of subcontractors in delay, but those individual delays caused the same or overlapping periods of delay to the main works, then the main contractor would only have to pay the employer once for that period of delay, but might be able to recover that same rate of LADs from each of the delaying subcontractors. While the possibility of a financial windfall may appear to be a good position to be in, it leaves the main contractor open to having the subcontract LADs clause challenged as an unenforceable penalty, something covered in the first LADs article in this series.
General damages and caps on liability
In practice, it may be difficult for main contractors to estimate accurately the delay losses that could be caused by a subcontractor. There are any number of possible scenarios resulting from a subcontractor being in delay. The consequences could range from no overall effect on the main contract programme to the main contractor facing delay claims from the employer and other subcontractors, as well as incurring its own costs as a result of such delay.
The commercial reality is that the potential level of delay losses a main contractor could suffer may be far greater than a subcontractor is willing to accept
Main contractors therefore sometimes prefer to rely on claims for general damages for delay in subcontracts. Indeed, many of the standard form subcontracts, including JCT, do not include LADs clauses. Although general damages mean that the main contractor has to prove its losses, this can be made easier by including an express clause in the subcontract where the subcontractor acknowledges that it is aware of the main contract rate of LADs.
That said, the commercial reality is that the potential level of delay losses a main contractor could suffer may be far greater than a subcontractor is willing to accept, particularly where the subcontract works form only a small part of the overall project. For this reason, the parties often agree to limit the amount of delay losses a main contractor can recover from a subcontractor – whether by way of LADs or as general damages.
This may be set at a percentage of the subcontract sum so that it is proportionate to the value of the subcontract works. Of course the value of the subcontract works is not necessarily a good indicator of the likely delay losses a subcontractor could cause, and so any cap would have to be considered on a case-by-case basis.
The next and final article on LADs essential law will review whether liquidated damages clauses survive termination of a construction contract.
Chris Busaileh is a senior associate at Charles Russell Speechlys