Are you stuck in one-way traffic? Liquidated damages and the Construction Act

A recent case said that the limits on when a developer may withhold payments to its contractor do not apply to a contractor that wants to withhold the payment of liquidated damages. Contract drafting bodies should correct this double standard.

The changes that the Construction Act introduced to assist cash flow after the last recession are now being put to their toughest test. For many, the amendments to the act, which are expected later this year, cannot come soon enough. However, most developers will not be among them.

Balfour Beatty’s recent dispute with developer Modus Corovest over the late completion of Blackpool’s Houndshill shopping centre shows why. Modus’ agent awarded Balfour only limited extensions of time. As a result, Modus was, it seemed, due liquidated damages of £2m. It took the option under the contract (a JCT1998 With Contractor’s Design) of claiming the £2m as a debt in court (albeit in proceedings that Balfour started).

The contract was silent on whether Balfour should give notice as a precondition to withholding payment. Unsurprisingly, Balfour gave no such notice.

In the converse position, when Balfour claimed payment from Modus, the contract required Modus to say how much it intended to withhold of the sum otherwise due (and its grounds) before the sum’s final date for payment, failing which it would lose its right to withhold. If the contract did not so provide, the Construction Act would have implied the same. In fact the JCT went further than the act, saying that without a valid notice Modus could not challenge Balfour’s entitlement to the sum it applied for; it must await the next interim payment (if there was one) or the final account.

The court held that the act’s purpose was to improve the cash flow of contractors and subcontractors, not developers. The act does not require a contractor intending to withhold payment of damages to notify that intention before the amount was payable on pain of losing its right to withhold.

The judge considered that his approach must match the JCT’s intentions because in response to the act it only amended the provisions of its standard forms dealing with interim and final payments and not the damages clause.

However, one should not read too much into the JCT’s amendments. As I have said, they went further than the act’s requirements. In addition, the House of Lords said the act applied to the repayments of damages if an extension of time was awarded after they had been paid – even though the JCT overlooked the point. The act protects the contractor by introducing into contracts a date for (re)payment and a final date for (re)payment of the liquidated damages.

Drafting bodies should now review the liquidated damages provisions in their contracts to remove any right to object to paying them

Developers may feel aggrieved by this apparent double standard. They may not rely on the act when they claim damages but the contractor may when it reclaims them.

And what of the term that suggests damages may be claimed as a debt? The court held that if completion dates are disputed, the developer is not entitled to summary judgment for damages calculated in reliance upon those disputed dates; the claim must go to trial, at which point the full extension of time entitlement is decided. It does not take much to raise such a claim, so the option to claim damages as a simple debt will often be academic. It is unlikely this is what the parties or JCT intended.

Sometimes none of this will matter because the developer will owe the contractor a sum greater than the damages and will deduct them from it. However, this approach may not be open to the developer that, say, defers levying damages to avoid demoralising the contractor before it completes the works.

This case has implications for many other standard forms that entitle developers to claim damages as a debt as an alternative to deducting them from sums otherwise due to the contractor. Their drafting bodies should now review the liquidated damages provisions in their contracts to remove any right to object to paying them unless, say, a notice is first given.

The proposed amendments to the act would permit, this with one exception. They do not permit a certifier to certify a negative sum (requiring a contractor to pay the developer) after deducting damages. This error may prove important, given the trend for contracts to provide for damages to be included in the calculation of certified sums rather than left for the developer to deduct.

Developers concerned at the cost that changes to the Construction Act may bring in terms of amending standard form contracts may welcome a change that assists their cash flow when it comes to damages – in what otherwise seems like one-way traffic.