One Of The Burning Questions In Construction Project – Are You Entitled To Reduction Of Liquidated Damages Upon Sectional Completion?

Introduction

Liquidated damages is not uncommon in a contract of a construction project where the assessment of financial loss of a delay is intractable and costly. By including a liquidated damages clause in the contract instead of resorting to the general damages remedy, contracting parties can better manage the risk of delay and anticipate the compensation recoverable with certainty. To explore the past, present and future of liquidated damages in Hong Kong, please refer to our previous article.

Despite the foregoing benefits of liquidated damages clause, complexity may arise when the contract does not incorporate a mechanism to adjust the liquidated damages upon sectional completion. In Eco World – Ballymore Embassy Gardens Company Ltd v Dobler UK Ltd [2021] EWHC 2207 (TCC), the lack of such mechanism has led to disputes as to whether liquidated damages could (or should) be reduced to reflect the sectional completion or partial possession of works.

Enforceability of the liquidated damages clause

Background

In Eco World – Ballymore Embassy Gardens Company Ltd v Dobler UK Ltd, the Claimant (“EWB”) was a property developer which contracted with the Respondent contractor (“Dobler”) to carry out the design, supply and installation of the façade and glazing works (the “Works”) of 3 residential blocks. The written contract (the “Contract”) entitled EWB to take possession of part of the Works prior to practical completion of the whole Works if it so wished. The liquidated damages for any delay had been specified as £25,000 per week or up to an aggregated maximum of 7% of the final contract sum (the “Liquidated Damages Clause”).

The contractual completion date was 30 April 2018 upon consent of both parties. However, Dobler failed to complete the Works by then and hence EWB took over 2 of the blocks by 15 June 2018. The Works did not achieve practical completion until 20 December 2018. After 3 adjudications, the parties came before the High Court of England and Wales disputing the damages payable by Dobler following the delay.

EWB submitted that (1) where an employer under a construction contract is entitled to take early possession and (2) the liquidated damages provisions do not enable reduction to reflect such possession, the liquidated damages clause shall be considered as a penalty clause and therefore void and inoperable. As a result, general damages shall be granted, not being capped by the liquidated damages originally agreed. On the other hand, Dobler submitted that as the Contract bestowed EWB with discretion to deduct the full rate of liquidated damages to a lesser rate, the liquidated damages clause shall remain effective.

Mechanism for adjusting the Liquidated Damages Clause

As a starting point, the Court construed the natural and ordinary meaning of the Liquidated Damages Clause. As the Clause did not contain any provision for sectional completion, Dobler was obliged to complete all the Works of the 3 blocks, failing which EWB will be entitled to the liquidated damages stipulated therein. As there was no mechanism for adjustment to be made to the rate of liquidated damages, Dobler was not entitled to any relief (such as reduction of liquidated damages payable) from liquidated damages to reflect the early take-over of part of the works by EWB before practical completion.

The penalty rule

Based on the Liquidated Damages Clause as construed above, the Court further considered whether the Clause, applying the same rate of damages as compensation for late completion for any part of the Works, is penal and hence unenforceable. Following the penalty rule laid down in Cavendish Square Holding BV v Makdess [2015] UKSC 67, the Court held that the Liquidated Damages Clause is valid and enforceable:

1.       as the Liquidated Damages Clause was negotiated by both parties who had the benefit of advice from external lawyers, the Court would be more cautious in interfering with the freedom of the parties to agree commercial terms and allocation of risk in their dealings;

2.       EWB had legitimate interest in enforcing the primary obligation of Dobler to complete the Works by the agreed completion date;

3.       quantification of the damages arising from delay would be difficult; and

4.       there is no evidence that the liquidated damages suggested by the parties is extravagant or exorbitant.

Is the cap of the Liquidated Damages Clause
binding on the general damages?

In the event that, contrary to the finding of the Court, the Liquidated Damages Clause was void or unenforceable, the Court still considered that the general damages to be granted to EWB would be subject to the cap of 7% of the contract sum under the Liquidated Damages Clause. By interpretation of the contract with the objective understanding of both parties in the commercial context, the Court held that “even where a liquidated damages clause is found to be wholly unenforceable as a penalty, it may on a true construction be found to operate as a limitation of liability provision” so long as it reflects the true intention of the parties to the agreement.

Hong Kong’s position

Similardisputes have also came before the Hong Kong Court of First Instance. In Penta-Ocean Construction Co Ltd v CWF Piling & Civil Engineering Co Ltd [2007] 3 HKLRD 233, the claimant sub-contractor sought leave to appeal against the arbitrator’s decision and argued that the penalty damages clause contained in their contract with the respondent contractor is a penalty as it does not make any allowance for a reduction in liquidated damages in respect of partial possession. They also argued that the respondent’s re-entry into partial possession is a full or partial waiver of the right to liquidated damages or an understandable wish to reduce the loss or inconvenience caused by the delay in completion. However, the Court refused to address these issues because of procedural irregularity, leaving the questions open for the arbitrator to decide upon remittance of the matter. As such the position in Hong Kong remains unclear.

Key takeaways

There is no hard and fast rule to determine the enforceability of liquidated damages provisions in the event of partial completion of work. Its enforceability hinges on proper interpretation of the contract, and a single rate for liquidated damages may still remain enforceable despite partial possession unless stated otherwise. Extra caution shall be taken when drafting construction contract, in particular whether liquidated damages can be reduced in the event of part possession to prevent future disputes.

Contributing Advisors