Liquidated damages after termination: Court of Appeal calls time on the uncertainty?
Commercial contracts where one party is obliged to supply goods or services by a specified date often contain liquidated damages clauses. These clauses set a pre-determined level of damages that a party is entitled to recover should delivery or completion not take place by the specified date. Construction contracts commonly use liquidated damages clauses to set the damages to be paid by the contractor to the employer in the event of delay beyond the stated completion date.
The commercial rationale is clear; liquidated damages promote certainty and avoid the need for the innocent party to establish its actual losses as a result of the delay (which can often be very costly and protracted).
However, there has been uncertainty as to whether liquidated damages could be levied in circumstances where the project is in delay and the employer terminates the contractor’s employment before completion takes place. There are a number of conflicting decisions on this point, with the English Courts adopting three broad approaches:
- Liquidated damages fall away completely and the employer may only claim general damages. The clause will only apply to those parts of the works (if any) which have been completed prior to termination.
- The employer can levy liquidated damages up-to the date of termination. Thereafter, he must claim general damages for loss arising from delay.
- The employer can levy liquidated damages up-to the date of completion by a replacement contractor.
In the recent case of Triple Point Technology (‘TPT’) v PTT Public Company (‘PTT’), concerning a software supply agreement, the Court of Appeal has provided guidance on this topic, which may impact how liquidated damages and the consequences of termination are drafted in contracts.
TPT supplied software to PTT and the contract provided for various milestones to be achieved. If the supply was delayed beyond the milestones, TPT was liable to pay liquidated damages from the due date for delivery “up to the date PTT accepts such work”.
Stages 1 and 2 of the project were completed (and accepted by PTT), albeit they were 149 days late. However, PTT terminated the contract before the subsequent stages had been completed. At the point of termination, the project was in significant delay. In the litigation that followed, one of the issues before the court was whether PTT was entitled to rely on the liquidated damages clause and, if so, whether the liquidated damages accrued up to the date of termination or beyond.
The initial finding of the Technology and Construction Court was that PTT was entitled to liquidated damages. In respect of stages 1 & 2 (i.e. the completed stages) this was up-to the date of completion and, in respect of the incomplete stages, up until the date of termination.
The Court of Appeal agreed with the TCC’s approach to stages 1 & 2 but disagreed in respect of its approach to the incomplete stages. It found that the specific reference in the contract that liquidated damages were to be applied “up to the date PTT accepts such work”, indicated that the clause could only apply in a situation where the original contractor complete the work. It did not and could not apply to sections of work which remained incomplete at termination. Therefore, in respect of those incomplete stages, PTT would need to prove its losses as general damages.
As to more general guidance, the court confirmed that there is no hard and fast rule. The impact of termination on any liquidated damages clause depends on the particular wording of the clause. That said, the judgment hints towards a preference to the first of the above approaches, i.e. the clause falls away entirely, rather than either of the other approaches, despite the more recent court decisions favouring these.
The Court’s guidance provides welcome clarity as to the approach the courts will take. However, an employer’s ability to claim liquidated damages following a termination, depends on the specific contract provisions. The wording of the various standard forms of construction contracts take different (intentional or not) approaches. In certain contracts, if not specifically amended, the wording could result in an employer not being able to recover liquidated damages in circumstances where termination occurs prior to completion.
By way of example, NEC4 states that liquidated damages are payable until the earlier of ‘Completion’ and taking over of the works. Completion, as defined, can only ever be achieved by the original contractor and so it seems likely that the liquidated damages clause would fall away if termination occurs prior to “Completion”.
In contrast, the termination provisions in FIDIC forms of contract specifically refer to the employer being entitled to payment of liquidated damages up-to the date of termination and would seemingly satisfy the Court of Appeal’s analysis in TPT v PTT that general damages only apply to post termination losses.
Whichever form of contract parties intend to use, prior to entering into contract they should carefully consider whether they are content to rely on general damages in circumstances where termination occurs prior to completion or whether liquidated damages are preferable. Depending on the answer, it may well be the case that the standard provisions will require amendments.