Liquidated Damages and Penalty

Provisions
Oman Wednesday 23 May 2018

Jonathan Sanderson
Contact: jon.sanderson@qgs.global, www.qgs.global

1
 Liquidated Damages and Penalty Provisions

Discussion to outline:
• What are Liquidated Damages (LDs) and what are their benefits and
drawbacks?
• Are LDs a cure at all?
• Typical LDs clauses
• Penalty provisions – Definition
• Common Law position on LDs and Penalties
• LDs General Points under Omani law
• General SA implications
• Discussion Q & A

2
What are Liquidated Damages and what are their benefits and drawbacks?

3
 Liquidated Damages - What are they?

• Defined as:

Liquidated damages – a contractual clause providing for the

payment of a fixed sum on breach

• Breach of contract entitles the innocent party to damages

• In construction contracts the Employer can incur damages if the
completion date is missed
• The sum should represent a genuine pre estimate of the loss that
would be suffered resulting from the breach
• Otherwise problem of calculation of losses and inherent difficulties

4
 Liquidated Damages - Benefits

• Employer’s perspective:
- Stops the need to prove or mitigate the loss of the employer, legally
complex, damages hard to evidence and quantify
- No obligation for the innocent party to mitigate loss
- Gives the employer certainty

• Contractor’s perspective:

- Limitation of liability for contractor

• Potentially huge losses otherwise
• Uninsurable in the market
- Allows the pre-agreed risk to be priced
- May motivate the contractor
- Provides certainty to the contractor
5
 Liquidated Damages - Drawbacks

• Potential to not reflect the reality of the loss suffered

• Often used as a threat…. You know what will happen if you don’t
complete…..

• Treatment often varies by jurisdiction

6
Are Liquidated Damages a cure at all?

7
 Liquidated Damages – A cure?

• LDs are usually disputed in arbitration

• LD are very rarely waived due to typical project overruns

(variations, delay, disruption)

• LD’s regime has been subject to debate for years and is

problematic…..

8
Typical LD clauses

9
 Typical LD Clauses

• Structure of clause:

- Obligation to meet [Completion Date]

- If fails, Company receives LDs regardless of loss

- LDs set out in Form of Agreement – sum per day/period

- LDs sole and exclusive remedy, regardless of loss. Exceptions:

• Variations
• Unenforceability / termination

- Agreed to be a ‘genuine pre-estimate of loss’

10
 Typical LD Clauses

Clause 47 (1)

If the Contractor shall fail to achieve completion of the Works within the time
prescribed by Clause 43 hereof, such extended time as may be allowed under Clause
44 hereof, then the Contractor shall pay to the Employer the sum stated in the
Appendix to the Tender as a penalty for such default for every day or part of a day
which shall elapse between the time prescribed by Clause 43 hereof or the extended
time as the case may be and the date of certified completion of the Works. The
Employer may, without prejudice to any other method of recovery, deduct the
amount of such penalties from any monies in his hands, due or which may become
due to the Contractor. The payment or deduction of such penalties shall not relieve
the Contractor from his obligation to complete the Works, or from any other of his
obligations and liabilities under the Contract.

[Sultanate of Oman, Standard Documents for Building and Civil Engineering Works
Third Edition July 1981]

11
 Typical LD Clauses

Clause 8.7 Delay Damages

If the Contractor fails to comply with Sub-Clause 8.2 [Time for Completion] the
Contractor shall subject to Sub-Clause 2.5 [Employer’s Claims] pay delay damages to
the Employer for this default. These delay damages shall be the sum stated in the
Appendix to Tender which shall be paid for every day which shall elapse between
the relevant Time for Completion and the date stated in the Taking-Over Certificate.
However, the total amount due under this Sub-Clause shall not exceed the maximum
amount of delay damages (if any) stated in the Appendix to Tender.

These delay damages shall be the only damages due from the Contractor for such
default, other than in the event of termination under Sub-Clause 15.2 [Termination
by Employer] prior to completion of the Works, or from any other duties, obligations
or responsibilities which he may have under the Contract.

Fidic Red book 1999 Conditions of Contract

12
 Typical LD Clauses

Typical Oil & Gas Contract (English Law)

If Contractor fails to :-

(a) achieve READY FOR START UP of the WORK or any part thereof on or before the
scheduled date for READY FOR START UP (KEY DATES) as provided in PART A of
SECTION III then the CONTRACTOR shall pay or allow to COMPANY those
Liquidated Damages for Delay at the applicable rate set out in PART B of
SECTION III ;
(b) achieve those the PERFORMANCE GUARANTEES listed in PART C of SECTION III
and COMPANY exercises its right to claim Liquidated Damages in respect of such
failure.
then CONTRACTOR shall pay or allow to the COMPANY those Liquidated
Damages set out in PART C of SECTION III

13
Penalty Provisions - Definitions

14
 Penalty Provisions - Definitions

• Definition:

Ø A punishment imposed for breaking a law, rule or contract

Ø Synonyms; punishment, sanction retribution, penance

Ø Therefore it may not be reflective of the loss actually incurred or an assessment

of the loss that would be incurred resulting from the breach.

15
Common Law position on LDs and Penalties

16
 Common Law position on LDs and Penalties

• Must reflect a genuine pre-estimate of loss

• If the LD Clause is enforceable, law will uphold the sum in the clause
• No further analysis is needed
• LDs must be paid even if no damage occurs

• Penalty clauses will not be enforceable

• Pertinent case: Dunlop Pneumatic Tyre Company v New Garage and Motor
Company [1915] A.C. 79

17
 Common Law position on LDs and Penalties

• Brief outline of case:

• Claimants supplied to tyres to the defendants, it was subject to an

agreement that the defendants would not resell them below list price

• The defendants agreed to pay £5 ‘by way of liquidated damages and not as
a penalty’ for every tyre sold in breach of the agreement

• The issue arose regarding the clause is it liquidated damages or a penalty?

• It was held that the clause was not penal and was a genuine pre estimate of
Dunlop’s potential loss (liquidated damages), therefore the agreement was
enforceable

• Noting that the price undercutting would have damaged the claimants
business, the ability to be precise in the pre-estimation of losses was
impossible

18
 Common Law position on LDs and Penalties

• The court laid down some guidance rules:

a) Expression used by the parties to describe the amount is relevant but not
conclusive

b) If the sum is extravagant and unconscionable in amount under consideration with

the greatest loss that could conceivably be proved to have followed the breach

c) Where the breach consists of the non-payment of money and the sum to be paid on
breach is greater than the sum which ought to have been paid, the sum is a penalty

d) There is a presumption (but no more) that where a single lump sum is to be paid on
the occurrence of one or more or all of several events, some serious and others not,
is a penalty

e) A sum is not prevented from being liquidated damages by the fact that precise pre-
estimation of the loss is impossible, but in this case it was reasonable in the
circumstances and not therefore a penalty

f) Noting that the above is judged at the date of the agreement and not the breach
19
 Common Law position on LDs and Penalties

• The court laid down some guidance rules:

• The burden rests to prove the damages are invalid by the party arguing that the
damages are ‘extravagant and unconscionable’

• Case of Philips Hong Kong Ltd v A-G of Hong Kong upheld the principle of LDs being
judged at the point of the agreement

• Lord Woolf…..

‘the court has to be careful not to set too stringent a standard and bear in mind that
what the parties have agreed should normally be upheld’ not least because ‘any
other approach will lead to undesirable uncertainty especially in commercial
contracts’

• Principles of Jeancharm Ltd (t/a Beaver International) v Barnet Football Club Ltd
[2003] EWCA 58

- Claimant contracted to provide football shirts to the defendant

20
 Common Law position on LDs and Penalties

• The court laid down some guidance rules:

• Principles of Jeancharm Ltd (t/a Beaver International) v Barnet Football Club Ltd
[2003] EWCA 58

• Issue of Interest to be paid at five per cent a week (260 per cent per annum) for
late payment of an invoice. Authority found in the Dunlop case

• Held that the sums set out were immodest and far beyond any attempt to estimate
loss, they were therefore invalid as a penalty

21
 Common Law position on LDs and Penalties

• In summary:

• LDs will be generally be used as the basis of the damages under common law
subject to the guidance rules

• Courts will resist the reassessment of the pre estimate of the damages (LDs) by
using the ‘Dunlop Principles’

• No need to prove loss but if court rules as a penalty, legal pleadings would need
to be made for Damages at Law in the alternative

• If pleading accepted need to prove loss

22
 Common Law position on LDs and Penalties

• In summary:

• 3 points to cover in alternative pleadings:

1. Prove type of breach …… (Did it happen?)

2. Demonstrate the damage sustained was due to the breach

3. Connect the type of breach with the damages sustained, considering remoteness
and foreseeability

23
 Common Law position on LDs and Penalties

• Drafting considerations:

• Incorporation potentially of:

‘Unenforceability of Liquidated Damages

In circumstances where any of the Liquidated Damages outlined in sub-

articles x to y inclusive here-of as being payable by the Contractor are
successfully challenged (or otherwise deemed in any judicial or arbitral
proceedings) as constituting a penalty or otherwise cannot be enforced
against Contractor, then the parties agree that the Contractor’s liability will
be instead for general damages at Law’

24
 Common Law position on LDs and Penalties

• Other interesting drafting issues:

Ø Suppose A and B enter into an agreement

• Standard form of Contract
• LDs to be in Form of Agreement

Ø Against the LD section of the Form of Agreement parties wrote ‘£ nil’

Ø B is delayed and A suffers a losses

Ø Can A sue for its actual losses or does the LDs clause work as a limitation /
exclusion clause ?

25
 Common Law position on LDs and Penalties

• Other interesting drafting issues:

• Temloc Ltd v Errill Properties Ltd (1988) 4 Const. L.J. 63

• Court of Appeal decided:

‘I think it clear, both as a matter of construction and as one of common sense,

that if (1) clause 24 is incorporated in the contract and (2) the parties complete
the relevant part of the appendix, either by stating a rate at which the sum is to
be calculated or, as here, by stating that the sum is to be nil, then that
constitutes an exhaustive agreement as to the damages which are or are not to
be payable by the contractor in the event of his failure to complete the works
on time’

• No damages available

26
LDs General Points under Omani law

27
 LDs General Points under Omani law

• LDs clauses are generally acceptable in GCC jurisdictions and Oman is no different

• No express prohibition against penalty clauses

• Terms are used interchangeably by the courts

• However the courts have discretion to adjust the level of compensation agreed

• The Party requesting the adjustment must prove the loss suffered does not
correspond to the amount agreed

• If fixed amount provided for is wholly unrelated to the amount of financial loss
suffered, court could consider this punitive and hence non-recoverable

28
 LDs General Points under Omani law

• LDs provided for under the Omani Civil Code:

- Article 267

1. If the subject matter of obligation is not a sum of money, the contracting

parties may determine the amount of compensation in advance by making
provision of same in the contract or in a subsequent agreement

2. In all cases, the court may, upon the application of either of the parties,
amend such agreement to make the compensation equal to the damage, and
any agreement to the contrary shall be null and void.

29
 LDs General Points under Omani law

• LDs provided for under the Omani Civil Code:

• Therefore Penalties and LDs can be included in the Contract

• Burden of proof rests with the party making the application to the court to ‘open
up’ the level of penalties or LD’s

• Consider:
• Contractor risk of seeking to review the damages through the court
could face the fact the damages could increase!

• Employer in theory could seek to make an application to review the

damages to the court, unlikely but can do so

30
 LDs General Points under Omani law

• The 3 points previously highlighted in Common Law would equally apply if the
damages were to be assessed by the court:

1. Prove type of breach …… (Did it happen?)

2. Demonstrate the damage sustained was due to the breach

3. Connect the type of breach with the damages sustained, considering remoteness
and foreseeability

31
 SA General Comments

• Increasing practice in the GCC region

• Enter into Supplemental Agreement (SA) to cure all ills

• Usually SA makes EOT award conditional upon the contractor completing the
work within a given timescale

• Issues:
• SA is not actually compensating for the delays already suffered

• SA is conditional in nature; We will give you ‘y’ subject to you finishing

by ‘x’

• LDs being levied for the full period if the Contractor misses the revised
(target) date

• SA extinguishes the entitlement forming the basis of the SA in the first

place

32
LDs Examples

33
 LDs Examples

• Example 1

• EPC Contractor in contract with power company

• Qatari Law

• EPC contractor was in delay

• Power company tried to impose LDs

• At the time of the delay there was an oversupply to the grid and the power
company would not have been able to sell electricity at the planned price

• Losses were reduced

• LDs not applied

34
 LDs Examples

• Example 2

• Oil and gas company contracted with fabricator of offshore topsites

• English law

• Fabricator was in delay – caused shipping slot to be missed

• Delayed commencement of production

• Actual damages were much greater than the cap in the LDs clause

35
Liquidated Damages and Penalty Provisions

Any Questions?

Jonathan Sanderson – Regional Director Oman

Jon.sanderson@qgs.global

Quantum Global Solutions

Bait Mahmiyat Building
Shatti Al Qurum
Muscat, Sultanate of Oman
PO Box 395
PC118
W: www.qgs.global

36