Liquidated damages may make contractors wince, but really they should be seen as a good and faithful friend – particularly when you consider the alternative
The use of liquidated damages clauses in building and engineering contracts is widespread.

Most if not all standard form contracts require the parties to agree upon a fixed, or liquidated, sum to be paid as damages for a particular breach of contract. Usually, but not exclusively, this is linked to the failure by the contractor to finish work by a date set out in the contract – assuming that the contractor was not entitled to any extension of time. If this happens, the contractor has to pay damages at a set rate per day or week for the period during which the works are incomplete.

The alternative to the use of a liquidated damages is to rely on the employer's right to claim general damages for a breach of contract. The employer might then be able to recover a greater sum than it might have stipulated as liquidated damages, but it will have to prove this loss has been suffered and that it flows from the breach in question. This could be difficult, time-consuming and expensive. Consequently, liquidated damages can save the employer time and money because it obviates the need to prove actual loss.

Case law has established that the liquidated damages clause in the JCT standard building contract operates as a ceiling on the contractor's liability because the employer will not be able to recover general damages instead and, certainly in the context of building contracts, if the liquidated damages provision fails any general damages the employer can recover is likely to be no more than it could have recovered as liquidated damages. So the advantage of the liquidated damages clause for the contractor is that it operates as a limitation on its liability for damages caused in the event of its delay, and provides a degree of certainty for costing purposes.

There are issues relating to the circumstances in which a liquidated damages provision may amount to a penalty and these would have to be reviewed whenever you are considering the level at which to set the rate of liquidated damages. It is clear, however, that subject to restrictions on the level of damages imposed, the law has developed towards the widespread use of such provisions, perhaps reflecting the fact that they offer advantages to employers and contractors over the position in common law, which requires proof of breach of contract and damages suffered.

It is therefore interesting to note that an option is available in a standard form contract to take the opposite course, and for the employer to choose to rely on recovery by way of general damages. This provision can be found in the GC/Works/3 Conditions of Contract for Mechanical and Electrical Engineering Works.

Condition 55 of the GC/Works/3, which deals with damages for delay, offers the employer the option to use the usual liquidated damages provision but goes on to state that if the relevant provision in the appendix to the contract has not been specified, the contractor immediately becomes liable to the employer to pay damages, the level of which is to be assessed by the project manager and which comprises the actual loss suffered by the employer. The matter may subsequently be adjudicated or arbitrated between the parties. Presumably, this formulation is intended to avoid the difficulties and uncertainty that would otherwise arise if no rate is specified in the contract.

The guidance notes to the contract point out that for a public sector employer the proof of such loss or damage in financial terms is frequently difficult or in fact impossible and that therefore the liquidated damages provision should normally be used.

This certainly reflects my experience of public sector clients in such circumstances. Contractors should also, however, approach this clause with caution.

While assessment of the level of damage by the project manager would assist in the process, it may not prevent subsequent disputes from arising that will end up being adjudicated or referred to arbitration with the usual time and cost consequences for both parties.