Liquidated damages: when are they penalties?

As many readers will be aware, the law on liquidated damages was recently changed in the Supreme Court decision in Cavendish Square v Makdessi.  In GPP Big Field LLP v Solar EPC Solutions SL, we have seen one of the first applications of this decision to a construction contract.

Facts

GPP engaged Prosolia to construct five solar power plants across the UK under five separate EPC contracts. Four of these contracts included guarantees by Solar EPC Solutions SL, Prosolia’s Spanish parent company.  Prosolia failed to complete the various projects by the required completion dates and subsequently became insolvent.

GPP claimed against Solar under its guarantees.  The case raised a number of issues but we are going to concentrate on the claims for liquidated damages.

Solar argued that the liquidated damages clauses were penalties and therefore unenforceable because:

• They were expressly described as a “penalty”. Clause 21.5 read that: “In the event of the delay of more than fifteen (15) calendar days for the date of commissioning the Contractor shall pay to the [Employer] a penalty… The maximum of the penalty for delays to the Works shall be two hundred and fifty thousand pounds sterling per MWp (£250,000/MWp)”.
• The five EPC contracts provided the same “penalty” of £500 per day per MWp, despite the fact that each of the solar energy plants would generate different amounts of energy.  Solar therefore argued that the pre-determined sum could not be based on a genuine pre-estimate of GPP’s losses.

Solar also argued that as one of the contracts had been terminated, the liquidated damages clause did not survive the termination of that contract.

Decision

The Court held that the liquidated damages clauses were not penalties, and were therefore enforceable, for these reasons:

• Liquidated damages provisions for delay are common in construction contracts and GPP and Prosolia were experienced commercial parties of equal bargaining power able to assess the commercial implications of such clauses.
• It is in the nature of liquidated damages clauses that they are often used when precise prediction of the likely loss is difficult.  They are therefore often expressed in round figures.
• The fact that the loss resulting from the breach may vary in amount depending on the actual circumstances at the time does not of itself give rise to any inference that the sum agreed is a penalty, provided it is not extravagant and unconscionable in comparison with the greatest loss that might have been expected, at the time the contract was made, to follow from the relevant breach.
• Ultimately, the sum specified did not exceed a genuine attempt to estimate in advance the loss which GPP would be likely to suffer from the relevant breach.  It was not in any way extravagant or unconscionable in comparison to GPP's legitimate interest in ensuring the project was ready on time.
• The references to “penalty” in the clause were only “equivocal indications”, it was the substance of the matter that was relevant. The Court also held that the liquidated damages provisions survived the termination of the contract. 

The Court relied on the earlier decision of Hall v Van Der Heiden (No 2) where the Court had held that a liquidated damages clause would survive the termination of the contract as a “matter of principle” because otherwise this would reward the defendant for their own default.

Conclusion

The Court’s decision that these provisions were not a penalty was perhaps not overly surprising, as it is rare for liquidated damages provisions in construction contracts to be held unenforceable as a penalty.  This decision does show that, following Makdessi, whether the liquidated damages was a genuine pre-estimate of loss is still an important aspect of whether the provisions are a penalty.  However, the Court will ultimately apply the test in Makdessi of whether the sum stipulated is exorbitant or unconscionable having regard to the innocent party’s interest in the performance of the contract. 

The decision that liquidated damages would survive termination is more surprising.  A common view is that liquidated damages should not be payable after termination, as in these circumstances the contractor loses control of the eventual time of completion.  Instead, the contractor should be liable for the losses incurred by the employer as a result of the termination of the construction contract, including the losses it has incurred as a result of any delay in the completion of the works.  In such circumstances, the contractor would not be “rewarded” for their own default if liquidated damages did not survive termination, instead the employer would be under a duty to mitigate its loss and to then prove the actual loss it had incurred. 

This article was written by James Worthington and Sam Johnson. For more information please get in touch with James via james.worthington@crsblaw.com or +44 (0)20 7427 6626