Liquidated Damages – A comparison between the common law approach and the UAE Civil Code

When it comes to construction contracts, the scope of liquidated damages is far wider than just thinking of delay damages. Fines and housekeeping charges are regularly imposed by the employer and levied against contractors, for breaches of site rules and other safety measures. However, can such charges be levied where no loss is actually suffered by the Employer?

For example, in the case of a safety rule breach where nobody was injured, the works weren’t interrupted, and no fine is levied against the Employer by a relevant authority relating to the breach, is that charge enforceable? Is the Employer allowed to apply such charges in order to dissuade the Contractor from conduct which could have theoretically had a serious impact on the project?

In common law jurisdictions, since the 2015 UK Supreme Court decisions in Cavendish Square Holding BV v Talal El Makdessi and ParkingEye Limited v Beavis (“Makdessi and ParkingEye”)^[1], in principle, the Employer can impose such charges. This is because, after Makdessi and ParkingEye, the UK Supreme Court clarified that parties were permitted to charge liquidated damages in order to protect their genuine commercial interests provided that the true character of the provision is not penal. This deviated from the prior general understanding that liquidated damages had to be a genuine pre-estimate of loss.

The requirement for a genuine pre-estimate of loss was perhaps made most famous by Lord Dunedin in the 1914 case of Dunlop Pneumatic Tyre Co Ltd v New Garage & Motor Co Ltd^[2] (“Dunlop”). Whilst on its face, the Makdessi and ParkingEye case seemed to upend 101 years of precedent, the decisions in fact aligned almost perfectly with the judgment of Lord Atkinson in Dunlop, where he stated:

“[The party levying the liquidated damages] had an obvious interest to prevent this undercutting, and on the evidence it would appear to me impossible to say that that interest was incommensurate with the sum agreed to be paid.”(emphasis added)

As such, whilst the loss that might have been suffered was not akin to the liquidated damages levied, such liquidated damages were permitted for the commercial interest that was being protected by applying such charge. This was exactly the focus of Makdessi and ParkingEye, determining whether there was a genuine basis upon which a party could levy liquidated damages against another. So, whilst Makdessi and ParkingEye was seen by some as revolutionary, it is perhaps better categorised as a correction. It essentially returned the principle back to a path that it had slowly strayed from over the prior 101 years, and an overly literal reading of Lord Dunedin’s tests for distinguishing a penalty from liquidated damages.

Whilst it is clear that the common law of liquidated damages no longer focuses exclusively on whether or not the sum to be levied is a genuine pre-estimate of loss, the position in the UAE with regards to such pre-agreed charges is not so clear. In fact, what is agreed seems to be largely irrelevant, as the court always has the power to amend such agreement, where the sum levied is not equal to the prejudice suffered. Article 390 of the UAE Civil Code^[3] provides as follows:

“1. The two contracting parties may fix in advance the amount of damages either in the contract or in a subsequent agreement, with due observance of the law provisions.

2. The judge may in all cases, at the request of one of the parties, amend such an agreement in order to make the amount assessed equal to the prejudice. Any agreement to the contrary is void.”^[4]

As such, Article 390 does not make it clear that liquidated damages can be levied to protect potential harm and commercial interests. Further to this, in all cases, the court has an absolute discretion to amend the contract to the effect that the damages payable aligns with the actual harm suffered. This even leaves the door open to the court to increase the agreed sum of liquidated damages where the loss is greater than the sum levied. Such discretion would even seem to be able to override any cap on liquidated damages that might have been agreed by the parties.

It is widely stated that ‘penalties’, as known in the common law context, are not prohibited in Civil Law. Such is true, and liquidated damages in the form of fines and charges applied for a breach of the site rules (where no actual loss or damage is suffered by the Employer) are not explicitly prohibited. It however remains the case that, with the way Article 390(2) is worded, the ability to enforce such provisions will always remain uncertain and can only be considered on a case by case basis.

However, a feature of the Dubai Courts is the ability to apply the Civil Code in a way that achieves a just outcome (being a feature I wrote about in an earlier article titled “The balance between Fairness and Certainty in UAE Construction Contracts”). Over the years, the court has also appeared to have adopted a sensible approach to this theoretical concern, opting to rarely use such discretionary power. To this point, there are no known cases where the court has increased a sum of agreed liquidated damages at the request of the Employer (including any increase of the liability caps that had been agreed by the parties).

In conclusion, whilst the greater level of certainty provided by common law is in contrast to the position under Article 390 of the UAE Civil Code, practice in Dubai generally provides that the court will give the parties freedom to contract, only stepping in where necessary to correct an injustice.  

 
^[1] [2015] UKSC 67, - https://www.bailii.org/uk/cases/UKSC/2015/67.html 
^[2] [1914] UKHL 1 (01 July 1914) - https://www.bailii.org/uk/cases/UKHL/1914/1.html
^[3] On the Civil Transactions Law of the United Arab Emirates State - Federal Law No. 5/1985
^[4] Translation as published in “Sader UAE Annotated Civil Code”.