Liquidated damages and limitations of liability

The issues

The Supreme Court has handed down its judgment in the software system dispute of Triple Point Technology, Inc v PTT Public Company Ltd. In its judgment, the Supreme Court considered the following three issues:

(i) the correct interpretation of a liquidated damages clause;

(ii) whether a limitation of liability clause excluding loss caused by "negligence" excluded losses arising from a breach of a contractual duty to use reasonable care and skill; and

(iii) whether part of a limitation of liability clause which provided a global cap on liability applied to the liquidated damages clause (in circumstances where another part of the limitation of liability clause expressly excluded claims for which there were "specific remedies expressly identified as such in this contract").

The contract

The contract in question was for the design, installation, maintenance and licensing of a software system by Triple Point for PTT, with payments made at key milestones. Phase 1 involved replacing PTT's existing software system and Phase 2 involved further development. The first two stages of Phase 1 were finished 149 days late, but PTT paid the invoices for that work. It later terminated the contract, however, leading Triple Point to sue for further invoices unpaid at that stage. PTT counterclaimed for liquidated damages for delay and further damages.

The contract provided for liquidated damages to be payable for delay, but also contained a cap on damages. That cap was subject to an exception for "negligence".

Liquidated damages clauses

In circumstances where the work had yet to be completed, Triple Point argued that the right to liquidated damages ended at the point of termination. Once the work is not going to be finished, it argued, then the purpose of liquidated damages for delay falls away. While recognising that the category into which a particular liquidated damages clause falls will depend upon the wording of the clause itself, the Supreme Court found that, unless the clause clearly provides otherwise, a liquidated damages clause will apply to any period of delay in completing the work up to, but not beyond, the date of termination of the contract. The fact of termination before completion does not extinguish the right to liquidated damages accrued by that point.

Meaning of "negligence" in cap carve-out

The contractual limitation of Triple Point's liability included a carve-out so that it did not apply to Triple Point's liability resulting from fraud, negligence, gross negligence or wilful misconduct.  PTT argued that the "negligence" part of this carve-out related only to the tort of negligence and not to any breach of the contractual duty to use reasonable skill and care.

The Supreme Court (by majority) held that reference to "negligence" in the cap carve-out should be given its ordinary meaning and therefore included breaches of a contractual duty of care. It disagreed with the Court of Appeal that "negligence" here was limited to breaches of a duty of care which arose entirely independently of those breaches (e.g. independent torts). Lord Leggatt also emphasised that clear words are necessary before the court will hold that a contract has taken away valuable rights or remedies which one of the parties to it would have had at common law (or pursuant to statute).

In this case, there was a difference between the limitation of liability clause in the main agreement and the limitation of liability clause in the licencing agreement that was included as an exhibit to the contract. The judgment also serves as a useful reminder of the importance of using priority clauses, especially in large complex service agreements that are often made up of a contract and multiple schedules and annexes.

Application of global cap to liquidated damages clause

In relation to the third issue, the Supreme Court agreed with the decision of the Court of Appeal and found that the cap did include any liquidated damages payable.  This turned on the wording of the relevant clauses, where the Court found that two sentences of a clause served separate functions and were in logical order. First there was a limitation on liability and, second, there was a limitation on the form of remedy. The limitation on the form of remedy contained an exception for special remedies under the contract, of which the liquidated damages clause would be an example. But that did not mean that the same exception should be written into the limitation on liability.

Drafting and interpretation points

There are two useful purposes of liquidated damages clauses. First, they fix in advance the damages payable for delay, often an intractable task, capable of giving rise to costly disputes. Secondly, they limit the contractor's exposure to liability of an otherwise unknown and open-ended kind, while at the same time giving the employer certainly about the amount it will be entitled to recover as compensation. Each party is therefore better able to manage the risk of delay in completion of the project.

The Supreme Court held that the parties must be taken to know the general law, namely that the accrual of liquidated damages comes to an end on termination of the contact. Parties do not have to provide specifically for the effect of termination of their contract. They can take that consequence as read. There is no reason why termination of the contract should deprive a party of its accrued right to recover such damages, unless the contract clearly provides for this.

The word negligence has an accepted meaning in English law. It covers both the separate tort of failing to use due care and also breach of a contractual provision to exercise skill and care. Again, here the Court gave a clause its natural and ordinary meaning. A strained meaning was not justified by the argument that the exclusion of damages for negligent breach of contract from the cap would then emasculate the cap. The important obligations about meeting the specifications for functionality and other absolute obligations in the contract meant that liability for negligent breach was not the core obligation of Triple Point under the contract.

The decision reflects the modern view of contractual interpretation - commercial parties are free to make their own bargains and allocate risks as they think fit, and the task of the court is to interpret the words used fairly by applying the ordinary methods of contractual interpretation. It also remains necessary, however, to recognise that a vital part of the setting in which parties enter contracts is a framework of rights and obligations established by the common law (and often now codified in statute). Although its strength will vary according to the circumstances of the case, the court in construing the contract starts from the assumption that in the absence of clear words the parties did not intend the contract to derogate from these normal rights and obligations.