Liquidated Damages and Pre-Agreed Compensation under the New UAE Civil Code: Article 340

How Will the New Civil Code Change the Enforcement of Liquidated Damages in UAE Construction Contracts?

Liquidated damages clauses are a cornerstone of construction contracts in the UAE, providing employers with a mechanism to recover compensation for delay without proving actual loss and giving contractors certainty as to their maximum exposure. Under Federal Law No. 5 of 1985 ("1985 Civil Code"), that certainty has always been qualified by the court's broad discretionary power under Article 390(2) to adjust pre-agreed compensation — upwards or downwards — to reflect actual loss.

On 1 June 2026, Federal Decree-Law No. 25 of 2025 ("New Civil Code") will take effect, replacing the 1985 Civil Code in its entirety. Article 340 replaces Article 390 as the mandatory provision governing pre-agreed compensation. It retains the court's power to intervene but, for the first time, expressly codifies the specific circumstances in which that power may be exercised and imposes a higher threshold for upward revision. For parties to construction contracts, whether FIDIC-based (where delay damages are typically provided for under Sub-Clause 8.7) or bespoke, this is a significant development that warrants careful consideration before the New Civil Code comes into force.

The Current Position: Article 390 of the 1985 Civil Code and Its Application in Construction Disputes

Article 390(1) of the 1985 Civil Code permits parties to fix in advance the amount of compensation payable in the event of breach. Article 390(2) then provides the court with an overriding discretion:

"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."

Two features of Article 390(2) are particularly significant: 

• The power is mandatory — the parties cannot exclude or restrict it by agreement, and any clause purporting to do so is void.
• The language is broad: the court may intervene "in all cases" to make the compensation "equal to the prejudice," granting a general discretion to adjust pre-agreed compensation in either direction.

As discussed in our earlier article, "Liquidated Damages – A comparison between the common law approach and the UAE Civil Code", this position stands in marked contrast to the common law approach. Under English law, following Cavendish Square Holding BV v Talal El Makdessi [2015] UKSC 67, a liquidated damages clause will be upheld provided it is not penal — that is, provided it does not impose a detriment out of all proportion to any legitimate interest of the innocent party. There is no general power for the court to adjust the agreed sum to reflect actual loss. By contrast, under Article 390, the court retains ultimate control over quantum, prioritising actual loss over contractual freedom.

In practice, however, the onshore UAE courts have exercised this power with considerable restraint. There are no known cases in which the court has increased agreed liquidated damages at the employer's request, and the courts have generally respected the parties' bargain, intervening only where there is clear disproportion. Nevertheless, the breadth of Article 390(2) has always left the position uncertain, particularly in relation to fines and charges levied for breaches of site rules where no quantifiable loss has been suffered.

Article 340 of the New Civil Code: Codifying the Grounds for Judicial Intervention

Article 340 of the New Civil Code retains the right of parties to agree compensation in advance, but fundamentally restructures the court's power to intervene. The broad, open-ended discretion of Article 390(2) is replaced by an express, enumerated framework setting out the specific circumstances in which the court may act.

Downward revision (Articles 340(2) and 340(3)): The court may reduce pre-agreed compensation in three circumstances:

• Where the debtor proves that the agreed amount was exaggerated;
• Where the debtor proves that the original obligation has been partially performed, such that the agreed compensation exceeds the loss actually suffered; and
• Where the creditor, by its own fault, contributed to the occurrence of the harm or exacerbated it. In addition, the court may decline to award compensation altogether where the creditor's fault significantly exceeds the debtor's fault.

Upward revision (Article 340(4)): A creditor may claim an amount exceeding the pre-agreed compensation, but only where the creditor proves that the debtor committed fraud (ghish) or gross negligence (khata' jasim).

This represents a material change from Article 390(2), which placed no express limitation on the grounds for upward revision. The overall effect is to strengthen the parties' freedom to contract whilst preserving the court's power to correct genuine injustice. A party seeking adjustment must now establish specific factual predicates, rather than relying on the court's general discretion.

What Does This Mean for the Penalty vs. Liquidated Damages Distinction in the UAE?

Under the 1985 Civil Code, the distinction between a "penalty" and "liquidated damages" — so central to common law jurisdictions — has been largely academic. However, the express codification of specific grounds for reduction may encourage closer scrutiny. The requirement for the debtor to prove "exaggeration" invites an assessment of whether the agreed sum bears a reasonable relationship to anticipated loss. A clause that is clearly penal, with no rational connection to any conceivable loss, may now be more readily characterised as "exaggerated" within the meaning of Article 340(2).

This may have particular implications for fines and charges commonly imposed in UAE construction contracts for breaches of site rules, housekeeping obligations, and health and safety requirements, which are often levied irrespective of actual loss. Under the common law, post-Makdessi, such charges may be upheld provided they protect a "legitimate commercial interest." Under Article 340, the court may reduce the charge if the debtor demonstrates the loss suffered is less than the sum levied.

Employers therefore really need to document the rationale for any such charges and, where possible, link them to identifiable costs.

Conclusion: A More Structured but Still Mandatory Regime

Article 340 moves the UAE's approach to pre-agreed compensation closer to the certainty that commercial parties have long sought. The court's power to intervene remains mandatory, but the grounds are now transparent and defined. The imperative for all stakeholders is clear. Review existing liquidated damages provisions; ensure that agreed rates are supported by documented pre-estimates of loss; and address the survivability of liquidated damages upon termination.

This article is for general information only and does not constitute legal advice. Independent legal advice should be sought in relation to any specific matter.