What you need to know about liquidated damages - part six

What should you do to make your liquidated damages provisions enforceable?

In light of the two stage test now set out for liquidated damages how, in practical terms, should one go about ascertaining the amount to include as a monetary value? Clearly a good starting point would be to take the wording of the first limb of the test and apply it. Set out what business interests you are seeking to protect through the liquidated damages provision. Depending on the nature of the clause and the novelty of the contract and project, that could require some reasonably detailed thought, or a fairly standard and simple list.

To try and put that into a real world context; a liquidated damages provision for late completion of a residential scheme of ten homes might have some or all of the following legitimate business interests to protect:

• recovering financing costs in the extended period
• paying any compensation to new owners who cannot move in
• paying extended and any additional site supervision costs
• reputation damage
• risk of residential market fluctuations, and
• deterrent from over-running.

You could assign specific sums to each interest ending in the liquidated sum to be applied. Indeed, each line item may itself have a calculation attached to it. Alternatively, you could simply jump straight to the bottom line amount having considered the interests to be protected. In either case, the key point is being able to demonstrate that the protection of legitimate business interests has been considered in ascertaining the rate to be used.

It would be unusual to disclose this consideration at the outset of a project (though perhaps if there is a particularly good, transparent and cooperative relationship it could add to that). This information is, rather, to be stored on file in case the rate used is ever challenged.

While the bar has been set high by the court in terms of what will fall over the line into being an unenforceable penalty, rather than a liquidated damage, there is a much more important factor to bear in mind. Market forces. The legitimate business interest that could, for example, be taken into account in the late completion of an oil pipeline, would generate such a large amount of liquidated damages that the risk to any contractor would be prohibitive.

To try and reduce the scope for challenge, once you have been through the process of identifying and valuing the legitimate business interests to be protected by the liquidated damages provision a confirmation could be added to the contract. Such a confirmation could be along the following lines “The parties hereby accept and understand that the liquidated sum protects the legitimate business interests of [ ] and that the sum is a reasonable one in all the circumstances”. While the end of that provision does not directly match the test set out by the court, the repetition of the sum not being extravagant, exorbitant or unconscionable, feels a little too much for normal circumstances.