Liquidation, termination, prolongation

As we await the judgment of the Supreme Court in the Triple Point case, we assess the current state of play, in light of recent developments in the world of liquidated damages.

Compared to the mostly glacial pace of legal innovation, recent years have been almost tumultuous in what had been a relatively stable environment for liquidated damages - one of the most potent weapons in the armoury of contractual remedies.

First, in 2015 in Cavendish Square Holdings BV v Tatal El Makdessi, the Supreme Court rather rudely described the rule against penalties as “an ancient, haphazardly constructed edifice which has not weathered well”, when they questioned the comforting rubric that every lawyer would learn at their mother’s knee – namely, that liquidated damages must be a genuine pre-estimate of loss, if they are to avoid the ignominy of being classed as a penalty under English law.

A test that was inspired in its simplicity and logic – although often ignored in practice - was supplanted in the Supreme Court by a more nuanced (for which some would read, less clear) benchmark. Now, liquidated damages must not be out of all proportion to the legitimate interest of the employer in the enforcement of the particular obligation (whether to complete on time, or to achieve a guaranteed performance), if they are to avoid being regarded as a penalty - although, in practice, a genuine pre-estimate of loss still provides a more readily understandable and practical benchmark, which will satisfy the Makdessi test in almost all circumstances.

And then, in 2019, the Court of Appeal in Triple Point Technology, Inc v PTT Public Company Ltd entertained the possibility that – subject always to the precise drafting of the contract in question - a liability to pay liquidated damages might fall away entirely on termination of a contract prior to completion of the works, even in respect of the period prior to termination.

This decision stands in stark contrast to the traditional approach that LDs are payable up to termination, but are then supplanted by an assessment of the actual delay losses incurred after that date, as part of the compensation on termination regime.

The Court of Appeal also considered a third option that LDs may continue after termination, until such time as completion is achieved by a replacement contractor. This approach is already favoured in some project financed deals, which introduce express drafting to this effect, in order to bring greater apparent certainty to the project company’s recovery of ongoing delay losses.

Dealing with this third option first, many contractors will instinctively resist this approach, as liability for a liquidated debt of an uncertain duration post-termination will be an unappealing prospect. All parties should also be aware that its implementation in practice will by no means be simple, given the inevitable questions that will arise as to the project company’s duty to mitigate the delay – such as how quickly a replacement contractor can or should be brought on board, how long that contractor should properly be allowed to complete the work, and what the impact on the ongoing LDs should be, if the project company and/or replacement contractor does not proceed with reasonable speed.

At least, however, the concept of post-termination LDs has a track record in the real world. The “opposing” view muted in Triple Point that LDs may fall away altogether on termination prior to completion – whether in relation to delay arising before or after – is more startling, and it’s difficult to see why this would be an option deliberately sought by any properly advised employer.

The problem in Triple Point appears to be that the drafting in question required completion of the works by the contractor in order to set the parameters of the liability for LDs, and that it did not explicitly or implicitly allow termination to do the same. Without such completion, the mechanism was deemed inapplicable and inoperable.

Perhaps not surprisingly, therefore, last October brought a simple and robust response to the musings in Triple Point by the publishers of the NEC suite. A brief amendment to Option X7 makes it clear that LDs will cease on the earlier of completion by the Contractor, take over by the Client, or the issue of a termination certificate by the Project Manager.

We suspect that many will applaud NEC in reinforcing the “traditional approach” to LDs, and will regard this approach as the usual benchmark, from which any departures – whether in project finance or otherwise - will be subject to specific negotiation and amendment.

Those who take this view will no doubt be looking to the Supreme Court to reaffirm the traditional approach and overturn the Court of Appeals’ decision, when judgment is delivered in the near future. On the evidence of the Makdessi case, however, it would be unwise to rule out the Supreme Court’s capacity to subvert established orthodoxy, when opining on liquidated damages.

Another apparent attempt to push the envelope on liquidated damages – albeit in a quite different direction - has also been a key talking point in the pre-release version of the second edition of the FIDIC Green Book. This is FIDIC's Short Form of Contract, and the new version is a long-awaited update to the first edition, published way back in 1999.

Whilst we will have to wait until its official release to obtain definitive details of the Green Book, the teaser issued in December suggests that FIDIC has adopted a similar approach to that taken with the updated Red, Yellow and Silver Books published in 2017 – i.e. the new Green Book is significantly longer, with far more emphasis placed on prescriptive process and procedure.

It is, however, the Green Book’s proposed approach to liquidated damages (in a broad sense) that may raise most eyebrows, as the pre-release version has taken the unusual and potentially innovative decision to liquidate part of a Contractor's claim for delay.

It does this by giving the Contractor an entitlement to recover predetermined “Prolongation Costs” from the Employer as a result of a “compensable” Extension of Time (although it’s not made clear what, if anything, an “uncompensable” EOT might be). Although EOTs will, of course, be available for a number of causes of delay, some of them entirely unrelated to the Employer itself, the fact that they may arise from the Employer’s breach does make this new remedy analogous to liquidated damages, at least in part.

These Prolongation Costs are defined as on-Site and off-Site overheads associated with the Extension of Time. They are to be calculated by reference to a slightly confusing formula set out in the Contract Data, which takes into account the value of the Works carried out at the time that the event giving rise to the Extension of Time occurs, and the average "Weight" of the on-Site and off-Site overheads per day (being 20% of the Contract Price divided by the original Time for Completion for the Works). The Prolongation Costs will be payable over the duration of the Extension of Time.

The Contract Data also states that Prolongation Costs shall be “the only compensation due from the Employer to the Contractor for an EOT resulting from a compensable delay". Rather confusingly, however, it goes on to say that "for the avoidance of doubt this provision shall not affect the Contractor's rights for other Costs (if any), such as disruption Costs (if any)". And Clause 11.1.3 states that "when the Contractor’s entitlement [in the event of an Employer’s Risk] is for “Cost Plus Profit and/or EOT” or for “Cost and/or EOT”, then the Contractor is entitled to an EOT, Prolongation Cost…and/or other Costs or Costs Plus Profit (as the case may be)".

So it appears that, whilst the Contractor's prolongation costs have been liquidated in relation to on-Site and off-Site overheads, it may still be entitled to claim separate unliquidated disruption costs (and potentially other costs as well).

It remains to be seen whether FIDIC will follow through with this innovation when the official version of the Green Book is published, and in what precise form, but – even if it steps back from doing so - it does pose an interesting question as to whether a Contractor’s delay claims can, or should, be liquidated.

In theory, such an approach could provide certainty and reduce the number of disputed claims over the course of a project. In practice, however, it could also lead to protracted discussions over the value of the Prolongation Costs that should be recoverable, or to attempts to liquidate other aspects of a Contractor's claim, and so further complicate the process of contract negotiation (which is an outcome that we suspect that FIDIC would not endorse).