Variations to construction contracts - when a liquidated damages clause may become unenforceable
19 November 2014
Construction contracts often contain liquidated damages (LDs) clauses which set a pre-determined level of damages that the employer is entitled to recover should certain specified breaches occur (most commonly delay). Such clauses promote certainty and help to avoid the need for costly and protracted legal proceedings.
To be enforceable, the level of damages must be a genuine pre-estimate of loss. This should generally be assessed at the date the contract was entered into.
However, the recent case of Unaoil Ltd v Leighton Offshore Pte Ltd , considered whether an LDs clause could become unenforceable if it was not re-considered following a variation to the contract.
In December 2010, Unaoil and Leighton entered into a Memorandum of Agreement (MOA) under which Leighton agreed to appoint Unaoil as its sub-contractor if it was engaged as main contractor in respect of an oil pipeline in southern Iraq.
The sub-contract sum was originally agreed at $75 million but was later amended to $55 million. The MOA contained a widely drafted LDs clause which provided that Leighton would pay Unaoil $40 million if it was awarded the main contract but subsequently did not adhere to the terms of the MOA.
Leighton was appointed as main contractor but did not enter into a formal sub-contract with Unaoil, claiming that Unaoil had been rejected by the ultimate employer. Unaoil brought proceedings that included an LDs claim for $40million.
The court found that Leighton was in breach of the MOA but rejected Unaoil’s claim for LDs. It stated that, although LDs clauses are normally to be assessed at the date the contract is entered into, where the contract is altered in a ‘relevant respect’ the date for assessment is the date of such amendment.
Therefore, whilst the court was prepared to accept that the LDs clause at the date of the original MOA may have been a genuine pre-estimate of loss, this was no longer the case “by a very significant margin”, following the reduction of the sub-contract sum.
The LDs clause was therefore unenforceable. Unaoil was instead only entitled in this regard to general damages for the loss of profit it could prove it had suffered as a result of Leighton’s failure to award it the formal sub-contract.
Construction, Engineering & Projects Partner Steven Carey, commented:
“On the facts the court’s decision is unsurprising. Any LDs clause set at 75% of the contract sum is difficult to justify. However, the court’s approach to variations may be significant. It is not uncommon for employers to omit works, however it is rare that LDs are re-visited. This decision suggests that there are circumstances when they ought to be.
For example, significantly changing the scope of works under a building contract so that the works when complete will produce a much lower level of income (eg rent) for the employer, say because the completed building will be much smaller, could mean that the liquidated damages payable for delay may no longer be a genuine pre-estimate of the loss that the employer will suffer in the event of late completion of the works.”