Paul Cott looks at contractual liquidated and agreed damages, and offers some tips on how to avoid the most common traps.

To any building industry professional even remotely familiar with the contractual documents – ideally entered into prior to the commencement of work – would be aware of the term ‘liquidated damages’. You may know them however, as ‘agreed damages’.

These are clauses written into contracts (or commonly, are already included in standard HIA domestic building contracts, etc) which provide for an agreed, set fixed amount or formula for working out the amount of damages that is or are payable by the builder for breaches of contract.

Importantly, they can be payable even if there is no actual financial loss suffered by the non breaching party. If such a clause does apply, they can be the only remedy available for delays, where the delay was or is caused by a breach.

The most common case where they do or can apply is in cases of delay in completion of a project where the work is completed beyond the agreed date. Unfortunately for the builder, they can be a trap in that you may not have specifically negotiated the amount of agreed damages which are to apply, and they may apply (or may not, see below) in cases where the delays are not caused by the builder’s fault. Critically, when they do apply, and there is no ‘defence’ to them, they can result in the builder having to pay a significant amount of damages to the owner or head contractor in the event of a breach.

Courts do have the power to strike down agreed damages clauses in the event of a challenge to them, on the basis that they are ‘extravagant’ or excessively high in amount. The idea behind specifying their amount is that they are to be a reasonable estimation made by the parties as to what the financial losses will be in the event of a breach of a contract.

They are not meant to be punishment per se or a ‘penalty’ for a breach. If they are excessively high in amount then the courts presume that they are made contrary to fairness and equity and possibly made to punish the breaching party. Then the clause can be ignored totally or the courts can in their discretion adjust the amount in some cases to a ‘reasonable amount’. Having said that, to ‘enlist’ the court’s assistance in this regard can obviously be expensive and time consuming.

In reality, however, to say (as touched on earlier) that both parties have agreed on the amount of agreed damages flies in the face of reality. The reality is that a party is often given a contract, given a chance to read it (possibly) and asked to sign it. There is often no opportunity to negotiate, or even no mention at all by either party as to the issue of agreed damages. Then they, apart from other very, very limited exceptions which barely rate a mention, apply to their potentially fullest extent.

This can unfortunately, as touched on earlier, result in potentially crippling consequences for a small building company where there is an agreed damages clause which can apply to the small business and also where the head contractor in the same case has the right to be indemnified for any agreed damages it itself may have to pay (as a result of the small building company’s conduct or omission).

Knowing how much your potential exposure is in the event of agreed damages being payable in advance of accepting the job can be critical. It may be that (if you can suffer the financial ‘hit’) you simply decline to accept the job. Or you may be able to negotiate the amount of agreed damages which may apply (and other terms, as well).

As said above, however, where the other party is a large sophisticated corporation or simply another client who you do a lot of work for, the reality may be that the contract is offered on a ‘take it or leave it’ basis and the choice to decline to accept the job just may not be a real practical choice that can in reality be taken.

‘Standard’ contractual measures can be taken where agreed damages may apply. Perhaps the main one is the ‘extension of time measure’. Such measures where effectively drawn up can apply for example in cases of inclement weather where such weather conditions actually cause the relevant delay and the clause applies widely to such conditions. They can also apply to other cases where due to causes beyond the builder’s control, the project completion date is delayed. That can be the crux of the issue, the reason for the delay.

Another, but more commercially oriented approach is to offer an ‘incentive bonus’. That is, instead of having a negative stipulation that damages are payable in the event of breach caused by delay, these work the reverse way and provide for a payment to be made to the builder in the event of on-time or even early completion.

Conclusion

Finally, and briefly, be careful with the crossing out of a dollar amount for agreed damages and the insertion of the word ‘nil’. This situation has in the past resulted in a court decision being required to be made where there was a dispute as to whether the use of the word nil excluded the possibility of general (unspecified in amount) damages being applicable to the case.

If the parties desire or agree that nil agreed damages are to be payable, then they should stipulate clearly as to whether it is agreed that the right to general damages (which would be the more common situation) still applies in the event of breach or not or whether the ‘nil damages’ clause applies exclusively.

As always, but particularly in this relatively complex area with potentially significant consequences, professional advice should be sought in cases where agreed or liquidated damages may be payable by you or to you in cases of a breach or breaches of a building contract.