Delay & Liquidated Damages: some new ideas from FIDIC
We are all used to the traditional idea behind delay (or liquidated) damages, so as Jeremy Glover explains, it was interesting to see FIDIC expanding the concept when they released the second edition of the Green Book.
Why do we have Delay Damages clauses?
In the case of Triple Point Technology, Inc v PTT Public Company Ltd [2021] UKSC 29 at [74], Lord Leggatt explained that:
“Such a clause serves two useful purposes. First, establishing what financial loss delay has caused the employer would often be an intractable task capable of giving rise to costly disputes. Fixing in advance the damages payable for such delay avoids such difficulty and cost. Second, such a clause limits the contractor’s exposure to liability of an otherwise unknown and open-ended kind, while at the same time giving the employer certainty about the amount that it will be entitled to recover as compensation. Each party is therefore better able to manage the risk of delay in the completion of the project.”
The FIDIC Guide to the 1999 Rainbow Suite takes a similar view, noting that the purpose of Delay Damages is to compensate the Employers for losses they suffer as a consequence of delayed completion. Where the amount of Delay Damages is pre-agreed, the intention is that the Employer does not have to prove actual loss and damage. The benefit of liquidated damages is that they avoid the difficulty (and expense) of proving and assessing actual loss where a delay occurs. For the Contractor, Delay Damages effectively act as a limit on their liability for delay. They also provide a degree of certainty for both parties.
Under the FIDIC 2017 second edition of the Rainbow Suite, the basic scheme is that:
- If the Contractor fails to complete their Works within the Time for Completion, the Employer is entitled to levy Delay Damages.
- The Delay Damages shall be deducted at the rate provided for in the Contract Data.
- The Contract Data provides for the maximum amount of Delay Damages to be capped.
- Unless the Contract is terminated, Delay Damages are the only remedy available to the Employer prior to Completion.
- The Delay Damages do not relieve the Contractor of their other contractual obligations.
- To recover the Delay Damages, the Employer must make an application in accordance with sub-clause 20.2.
The precise way in which a Delay Damages clause might work will depend on the law under which the Contract operates:
- In South Africa, under the Conventional Penalties Act 15 of 1962, the court can reduce the amount of Delay Damages that might be applicable if the Contractor can show that the Employer will be unjustly enriched if they receive the Delay Damages as specified in the Contract. For example, if the Employer does not suffer any loss due to the Contractor’s delay.
- In Qatar, Article 265 of the Civil Code allows the parties to to calculate the amount of damages payable in the event of delay. However, by Article 266, the court can reduce the Delay Damages if the Contractor can show that the Employer has not suffered any loss, or if the amount claimed is exaggerated. By Article 267, the amount of Delay Damages agreed in the Contract Data will act as a cap on the damages payable, except in circumstances of fraud or gross mistake.
- In contrast, in the UAE, under Article 390 of the Civil Transactions law (Civil Code), both the Contractor and the Employer may challenge the element of “loss”. Article 390(2) entitles the Judge to vary the parties’ agreement to reflect the actual loss. A court may set aside the liquidated damage entirely in the unlikely event of the employer suffering no loss from the delay. Further, the court may also reduce the damages to reflect the actual loss. In both scenarios, the burden of proof is placed squarely on the Contractor. Similar standards will be applied to the Employer who is trying to argue that their actual loss exceeds the liquidated damages.
- Under English law, a liquidated damages clause will not be enforceable where it constitutes a “penalty”.1 In the case of Cavendish Square Holdings BV (Appellant) v Tatal El Makdessi (Respondent)2, the Supreme Court held that:
“… a secondary obligation which imposes a detriment on the contract-breaker out of all proportion to any legitimate interest of the innocent party in the enforcement of the primary obligation. The innocent party can have no proper interest in simply punishing the defaulter. His interest is in performance or in some appropriate alternative to performance. In the case of a straightforward damages clause, that interest will rarely extend beyond compensation for the breach … But compensation is not necessarily the only legitimate interest that the innocent party may have in the performance of the defaulter’s primary obligations”.
However, whatever the jurisdiction, parties should be aware that, as a starting point, the courts will attempt to respect the parties’ agreement. The result in practice is that the courts are reluctant to vary the Liquidated Damages clause unless it is evident that the liquidated damages considerably exceed the actual loss. In the English case of Alfred McAlpine Capital Projects Ltd v Tilebox,3 Mr Justice Jackson noted that only four cases had been referred to him where the relevant clause had been struck down as a penalty. Even allowing for the fact that the more obvious cases would be unlikley to reach the courts, that is a very small number indeed.
it is always sensible to keep a record explaining why the amount of the liquidated damages was set at the level it was, and why it represents a reasonable and proportionate figure based on actual estimates and, at least in the UK, why it acts as a protection of a legitimate commercial interest.
In Eco World-Ballymore Embassy Gardens Co Ltd v Dobler UK Ltd,4 Mrs Justice O’Farrell said that:
“The liquidated damages provision was negotiated by the parties, who both had the benefit of advice from external lawyers… The court should be cautious about any interference in the freedom of the parties to agree commercial terms and allocation of risk in their business dealings… [Liquidated damages provisions] limit the contractor’s exposure to an unknown and open-ended liability, while at the same time giving the employer certainty about the amount that it will be entitled to recover as compensation. Each party is therefore better able to manage the risk of delay in the completion of the project.”
Extending the delay damages principle
The second edition of the FIDIC Green Book, which came out in 2021, has taken the basic principle behind Delay Damages (in the sense of a pre-agreed contractual rate) – certainty and the avoidance of incurring unnecessary time and costs in disputing the amounts that may be awarded to a party – and extended it to prolongation costs.
The 1999 first edition already had fixed pre-agreed amounts payable for loss of profit in the event of termination. In the 2021 edition, sub-clause 10.4 fixes a Contractor’s loss of profit in the event of termination for cause by the Contractor or termination for convenience by the Employer at 10% of the value of those parts of the Works not yet executed at the date of termination. The same rate applies where works are omitted.
For the Employer, liquidated damages for losses arising from a termination for cause are set at 20% of the value of those parts of the Works not executed at the date of the termination. The new edition makes it clear that this is an exclusive remedy.
The treatment of prolongation costs is bolder and new to FIDIC. Clause 1.1.35 defines prolongation costs as: “the only compensation due from the Employer to the Contractor for an EOT resulting from compensable delay”.
Clause 11, which deals with Risk and Responsibility, contains a table setting out details of the Contractor’s potential entitlement. This table includes reference to Prolongation Costs. Not only is this a defined term, but there is also a set formula in the Contract Data detailing how to calculate the compensation for onsite and offsite overheads per day of compensable extension of time. This is based on the “average weight” of the Contractor’s onsite and offsite overheads per day, and the value of the works executed at the time of the delay.
FIDIC are clear within the Guidance Notes that their new approach is based on “a liquidated damages provision, for ease of use by the parties”.
The Green Book is intended for use on (relatively) lower value projects and FIDIC is looking to reduce the time and cost associated with these losses, which can be quite complex and require expert evidence. The new approach is also in line with FIDIC’s philosophy of trying to make their contracts clearer, so that everyone knows where they stand; the ultimate aim being to help to avoid disputes.
A greener way forward?
So, will FIDIC look to extend the practise in other ways?
FIDIC is currently setting up a task force to consider how to deal with net zero and other sustainability provisions. One possible option might be the use of pre-agreed damages for a failure to achieve pre-agreed reductions in emissions or other environmental targets. For now, at least, this might be too ambitious as it would require a detailed understanding on all sides of the agreed targets and methods of reporting. Degrees of understanding vary widely and so this may not be achievable, or at least achievable fairly, without loading risk on to the Contractor. Liquidated damages are not a one-size-fits-all solution.
Perhaps a fairer, better way forward to setting and achieving carbon emission targets might be to adopt a more collaborative approach to incentivise all parties to achieve the climate goals on a particular project.