What are liquidated damages?
Parties funding a construction project need assurances that the project will be completed in time and to their standards. Delays or mistakes can lead to financial losses. The paying party (the client) (usually the employer or main contracting firm) must be compensated in the event of a problem.
It’s common to include clauses in these contracts that protect the client against such losses. Land development is a very slow process, so delays are common. This clause provides clarity and certainty for all parties from the beginning and avoids the need to engage in costly legal arguments or analyses about what losses can be proven proceedings when things go awry and the work is stalled. This article explains liquidated damages, their conditions and how they are different from general damages. Helix Law can provide you with further advice.
What Is Meant by Liquidated Damages?
Liquidated damages are a specified sum of money paid to a party to a construction contract in case of a breach of its provisions in relation to the completion date. They are compensation to the party that suffers a loss due to the delaybreach.
When parties enter into a contract for construction, they will agree how much money they will pay each day, week, or month that the contract is delayed beyond the completion date if the other party breaches any of its terms. The parties will state the amount due in the contract, which they usually set at a rate per day or week.
Essentially, the parties must quantify their potential losses in advance; the party in breach will pay the agreed amount without the other party having to prove the exact loss suffered.
What Is an Example of a Liquidated Damages?
Imagine a landowner hiring a construction company to develop a block of residential flats. The contract stipulates that the landowner must have the builder complete the project by the 31 December deadline. The contract will include a separate clause, called a liquidated damages clause, which states that the construction company must pay a fee of PS1,000 per day for the delay in project completion.
If they do not complete the project by 5 January of the following year, then they are in breach and must compensate the landowner with PS5,000.
While delays are the most common cause of this type compensation, it can also occur if a person breaches another obligation. If a party fails to meet their obligations, the other party can claim this type of compensation provided it is stated in their agreement. If they fail to do so, the other party can claim this type of compensation provided it is stated in their agreement.
What Conditions Must Be Met to Enforce Liquidated Damages?
The general rule is that the court will uphold them if the relevant contract term is fair and reasonable. This requires the parties to consider the following:
The amount stated must reflect a reasonable and proportionate estimation of losses. It can be difficult to estimate the loss in advance. However, the parties must take all necessary steps to accurately quantify the loss. Consult a construction expert if you want to make sure the amount is realistic.
- The damages must be intended as compensation and not as a penalty. They are intended to compensate the non-breaching side for their losses. Therefore, an excessive amount for a relatively minor violation is unlikely to be enforced.
- The contract term in question must clearly state how much is payable under different scenarios, what trigger event will lead to payment and how the rate was set (e.g. per day). A lack of clarity may result in a court removing the clause, or the non-breaching side receiving less than expected.
- If there is no financial loss as a result of a delay, the party that has breached the contract could try to have the damages set aside on the grounds that the other party does not need compensation. Parties should therefore keep accurate records and financial statements to prove their losses. How to calculate liquidated damages?
- The contractual completion date is the date from which Liquidated Damages begin. Liquidated damages will continue to accrue up until the contract has been completed or terminated. If the contract is terminated, the LADs cease regardless of whether or not the work was completed.
What are General Damages?
General damages are another form of compensation awarded to a non-breaching party who suffers a loss due to another party’s breach of contract. The loss is not determined in advance, but must be reasonably foreseeable and calculated after the event.
They will apply if the contract does not contain a clause for liquidated damage. The party claiming damages will need to prove both the breach and their direct loss. A delayed project could cause the landowners to lose income by renting out their properties. They can claim general damages for compensation.
The Differences between Liquidated Damages and General Damages
There is a wide range of differences between these two types compensation. Each has its own advantages and disadvantages. The table below summarizes the key differences.
General Damages
Liquidated Damages
| Amount | Determined after the breach and calculated based on actual loss. | |
| Determined in advance on the basis of a reasonable estimate. Specificated in the contract. | Certainty | Uncertainty as to how much is payable. Compensation is based on the agreed amount between the parties or the amount ordered by the court. The amount payable is specified in the contract and is known. |
| Foreseeability | Loss must be foreseeable and a direct result of the breach. | Loss is not required to be foreseeable, as long as it is clearly identified in the contract between the parties. |
| Purpose | To provide compensation for general losses resulting from a breach. | To compensate for specific losses at a predetermined amount. |
| Enforceability | The non-breaching party must establish the following: | BreachLoss as a result of the breach Reasonable foreseeabilityAttempts to mitigate loss |
| The non-breaching party must establish: | Breach A reasonable and proportionate estimation of losses An intention to compensate Evidence |
There must be evidence of the actual loss suffered. There is no need to prove actual loss. Parties are advised to seek legal advice regarding the best arrangement for their construction contract as it will depend on their circumstances. |
| Frequently Asked Questions | What Are Liquidated Damages Under UK Law? | Liquidated damages are a form of compensation specified in construction contracts–the contract predetermines when and how much a defaulting party pays the other in case of a breach – usually delay. The amount must be reasonable, proportionate and does not penalize the party who has broken the contract. What happens if Liquidated damages are stated as PS0 under UK law? |
The innocent part will not recover any compensation for LADs, or general damages as the parties have agreed that the compensation amount is zero. When filling out a contract leave the LAD’s blank or not applicable to avoid agreeing zero damages.
Final Thoughts
Including a liquidated damages clause in a construction contract is an excellent mechanism for ensuring certainty and clarity regarding what happens when there is a breach. These clauses help parties avoid lengthy and costly legal disputes over the quantity of losses.
However, for liquidated damages to be enforceable, the amount must be a reasonable estimate of potential losses and intended to compensate, not penalise. If the contract does NOT include a liquidated damage clause, general damages will be applied. Proof of the losses must also be provided. This includes adjudications and enforcement, as well as technology and construction-related litigation. Our experts can help you if you want to make sure your construction contract is enforceable and covers all possible scenarios, or if there’s a dispute. Helix Law can provide you with more information.
