Developments in contract: Liquidated damages

Principles

• Liquidated damages are a fixed or determined sum agreed by the parties to a contract to be payable on breach by one of the parties, commonly in the case of delayed performance.
• When a contract for works (e.g. in a construction context) is terminated, a court will consider the drafting of the contract carefully to assess whether liquidated damages will survive termination, particularly if the underlying works have not been completed at the point of termination.
• There are three possible ways for a Court to apply a liquidated damages provision: (i) to all works until completion; (ii) to all works until the date of termination; or (iii) only to works completed prior to termination. The applicable outcome will turn on the wording of the liquidated damages clause.

Recent developments

• In PBS Energo v Bester Generacion, PBS (the employer) was found to have wrongfully terminated a contract for the construction of a biomass energy plant (which was never completed), based on alleged breaches by the contractor, Bester. Bester was therefore itself entitled to terminate and claimed damages under a liquidated damages clause in the agreement.
• PBS asserted that the liquidated damages clauses supposed that the project would be completed, and that separate clauses in the agreement provided a comprehensive code for compensation in the event of termination prior to completion. This would have allowed Bester to recoup its cost of capital expended during the contract. PBS contended that these clauses excluded Bester’s claims for liquidated damages.
• The judge disagreed and allowed Bester’s claims for liquidated damages, relying on the wording of the liquidated damages clause. In this case, the parties had explicitly agreed that the entitlement to liquidated damages would accrue from the time at which the works should have been completed (rather than actual completion), and that this accrued right was to be unaffected by termination.

What this means

• Parties drafting liquidated damages clauses in construction contracts should take particular care to make provision for the eventuality that the contract might be terminated prior to the completion of the underlying works. The contract should deal expressly with the issue of whether liquidated damages will survive termination in those circumstances.
• This case serves as another reminder to parties to make certain that they are entitled to terminate before doing so and to comply with all formalities required for termination. A wrongful termination will usually itself give rise to a right on the part of the innocent counterparty to terminate and claim for damages.