LADS - penalties or a genuine pre-estimate of loss?

01/09/2009

By Chris Kirby-Turner, Solicitor in Construction & Engineering.

Where a contractor is in culpable delay, it has long been a requirement that where the contract specifies a sum in respect of Liquidated & Ascertained Damages (LADS), they must be a genuine pre-estimate of the employer's losses.

A contractor faced with a considerable deduction in respect of LADS may often seek to challenge whether, as a matter of fact, the sum is reasonable. If the contractor can satisfy the court that the sum is overstated and amounts to a penalty, the court will not allow the deduction to be made. The penalty clause will be held to be void in its entirety. In such cases, the employer must then attempt to satisfy the court as to the extent of his loss and damage as a result of the breach, in accordance with general common law principles (which will include consideration of whether any loss has been mitigated and whether there is any proper counterclaim or set off, etc).

One important factor that will have a fundamental impact on the anticipated losses and their pre-estimate is any arrangement for the sequential phasing of the works. In particular, the LADS mechanism must genuinely reflect the losses that will flow as a result of the delay. This question was considered by the Technology & Construction Court in the case of Liberty Mecian Ltd v Dean & Dyball Construction [2008].

The facts

The facts of the case were that the contractor was engaged to undertake the construction of four new retail units. It was common ground that the first unit was to be completed during the first phase of the project, in order that a retailer could then move into that unit from another unit on the site, thereby freeing up its old site and associated car parking which were to be subject to later phases of the project.

The contract was in the form of the JCT Standard Form of Building Contract, 1998 edition 2003 revision. The contract was amended and referred to an appendix which sought to clarify the dates for each of the sequential phases, together with the LADS figure that applied in respect of each phase and sub-phase.

Section 1 of the project was subject to various delays, which led to an extension of time of four weeks being granted, with a further four weeks' delay found by the architect to be culpable delay.

The court's approach

The contractor maintained that, because completion of Section 1 had been delayed by eight weeks, it should be entitled to an extension of time of eight weeks in relation to each subsequent phase, regardless of the cause of delay.

In considering the matter, the court confirmed the well established case law in this area. In particular, the court confirmed its general wariness of allowing a party to avoid the consequences of a liquidated damages provision that had freely been entered into. This is a question of balancing the commercial necessity of certainty against instances where there is a lamentably “unfair” application of the LADS provisions that would see the Employer recovering far more than their true losses. As an example, in Bramall and Ogden Ltd v Sheffield City Council [1983], the LADS provisions were held to operate as a penalty because whilst the contract (and the LADS mechanism) did not contemplate sectional completion, this was actually what was happening on the ground.

That case was criticised as being an overly strict construction of the contract, and led to changes being made to the JCT forms of contract. However, in the recent case of Braes of Doune Windfarm (Scotland) Ltd v Alfred McAlpine Business Services Ltd [2008] the court again found an instance where the LADS provision, owing to deficiencies in the drafting of the clause, had the effect of operating as a penalty clause and was therefore unenforceable.

In the Liberty Mecian case, having clarified the law in this area, the court considered the effect of the essential sequential nature of the works. The court was satisfied that it was clearly anticipated that a culpable delay to the first section would have an inevitable consequence of a delayed commencement (as a culpable delay) to each subsequent section. Therefore, the court was satisfied that LADS at the rate stated for each section should apply for that four week period.

Conclusion

Ultimately, the result of this case turned heavily on its facts, in light of the common intention of the parties and the precise wording of the contract. Whilst the documentation was not perfect, the court felt able to interpret the provisions with sufficient precision to give effect to what they deemed had been in the common intention of the parties at the time of the contract.

Another point that should be remembered when preparing the contract documents flows from the decision of Temloc v Errill Properties (1987). In that case, it was held that where "£0" or "£nil" is inserted as the figure for LADS, the effect is to prevent an employer from bringing any claim for provable loss arising from culpable delay - the rationale being that he is pre-estimating his loss to be of nil value. Inserting "£N/A" will be treated in the same way. If it is not possible to properly pre-estimate losses then an employer must amend the contract to remove the LADS provisions in their entirety. Whether a contractor will find it commercially palatable is another issue.