Will your LADs survive termination?
Those involved with construction and engineering contracts recognise the benefits of agreeing a predetermined level of damages (LADs) which will be payable to the employer, and which will operate as an exclusive remedy in the event the works are delayed beyond the specified completion date. Within this framework, the question as to whether the LADs agreed at the outset will survive the termination of a contract in delay is an important one. Part of the answer is, of course, that it depends on what the contract says. However, as Marc Wilkins explains, the judgment handed down by the Court of Appeal in Triple Point Technology Inc. v PTT Public Company Ltd1 earlier this year has prompted those involved in construction projects to look at the provisions relating to LADs.
Liquidated (or delay) damages clauses (LADs) provide certainty as to the consequences for the contractor in the event of breach. They operate as a limitation on the contractor’s liability and, from the employer’s perspective, dispense with the need to incur the time and cost of proving the actual losses in the event of a breach. When it comes to whether or not LADS survive termination three distinct approaches have emerged from the courts over the past 100 years or so in response to this question. They are: (1) yes, the LADs will survive termination — and will continue to accrue up until the point at which the works are completed by someone else; (2) yes, the LADs will survive termination, but will only apply up to the point at which the contract is terminated; and (3) no, the entitlement to LADs will fall away entirely on termination.
Background
The Triple Point case concerned a contract entered into between PTT, a company which among other activities trades in oil, refined products and petrochemical, and Triple Point, a company that designs, develops and implements software for use in commodities trading. PTT had engaged Triple Point to design and install a new Commodities Trading, Risk Management and Vessel Chartering (CTRM) system, and then to develop that system to accommodate new types of trade. The works were to be carried out in phases and the parties had agreed that PTT would make payments against certain milestones within the phases.
The contract included a provision dealing with PTT’s entitlement to damages in the event Triple Point failed to achieve the various milestones within the specified time for doing so. Article 5.3 provided that:
“CONTRACTOR shall be liable to pay the penalty at the rate of 0.1% (zero point one percent) of undelivered work per day from the due date for delivery up to the date PTT accepts such work …”
Whilst milestones 1 and 2 of phase 1 were delayed beyond the specified date for completion, they were ultimately completed and accepted by PTT. However, prior to Triple Point completing any subsequent milestones or phases, a dispute arose between the parties which resulted in the contract being terminated – the dispute concerned Triple Point’s entitlement to further payments. PTT’s refusal to make further payments pursuant to invoices issued by Triple Point (on the basis that the milestones/phases to which those payments related had not been achieved) resulted in Triple Point suspending its works. PTT considered the suspension to be unlawful and terminated the contract. That prompted Triple Point to commence proceedings seeking payment of all outstanding sums shown as due on its unpaid invoices. PTT defended that claim and counterclaimed for delay damages and damages due upon termination of the contract.
At first instance, Mrs Justice Jefford found in favour of PTT, dismissing Triple Point’s claim in its entirety and awarding PTT US$4.5 million in respect of its counterclaim, of which US$3.46 million was in respect of LADs pursuant to Article 5.3, made up as follows:
(i) US$154,662 in respect of the delay to completion of milestones 1 and 2 of phase 1 (i.e. from 13 October 2013 to 19 March 2014, the date of completion); and
(ii) US$3,304,616.40 in respect of the delay to all other elements of the work from the specified completion dates to 15 February 2015, the date of termination.
Therefore the LADs provision was held to be applicable both where specified stages had been completed and accepted by PTT, and also where specified stages remained incomplete at the date of termination, albeit only up to the date of termination.
Triple Point appealed that decision. Unsurprisingly, one of its grounds of appeal was that LADs for delay were irrecoverable. Triple Point’s reasoning for challenging the decision on PTT’s entitlement to LADs was firstly that Article 5.3 was in fact a penalty clause which imposed a detriment that was “out of all proportion to any legitimate interest of the innocent party” and, secondly, that in any event Article 5.3 was not engaged as it applied only to work which was delayed but subsequently completed and accepted by PTT, but not to work that was never “accepted” by PTT. Therefore, Triple Point was essentially arguing that by terminating the contract, PTT had lost its entitlement to LADs.
The decision of the Court of Appeal
In respect of the first ground for challenging the LADs awarded, Triple Point relied on the Court of Appeal’s judgment in Cavendish Square Holdings BV v Makdessi.2 The Court of Appeal held that despite Article 5.3 referring to a “penalty” and despite the contractual formula not being perfect, it did represent a genuine pre-estimate of the losses likely to flow from delay.
Of the second ground, the Court of Appeal said this:
“This is a formidable argument which raises questions of general principle concerning the operation of liquidated damages clauses in termination and abandonment cases ...”
In dealing with this second ground, the Court of Appeal reviewed the authorities relevant to the application of LADs going back to the early 1900s and noted that three distinct approaches had emerged as to how the LADs provision is applied in circumstances where the contractor fails to complete and a second contractor steps in to complete the works. They are as follows:
(i) The LADs clause does not apply (the “Glanzstoff” approach);
(ii) The LADs clause applies up to termination of the first contract (the “Greenore” approach); and
(iii) The LADs clause continues to apply until the replacement contractor completes the work (the “GPP and Hall” approach).
On the wording of Article 5.3, and in particular the phrase “up to the date PTT accepts such work”, the Court concluded that the “Glanzstoff” approach was the correct approach on the basis that this provision was “focussed specifically on delay between the contractual completion date and the date when Triple Point actually achieves completion” and that it “has no application in a situation where the contractor never hands over completed work to the employer”.
The “Glanzstoff” approach
This approach reflects the view that LADs provide a remedy for the employer in the event that the contractor completes the work late, but in the event the contractor does not complete the work due to the contract being terminated or abandoned, then the employer should be entitled to general damages. Of this approach, Sir Rupert Jackson said:
“I see much force in the House of Lords’ reasoning in Glanzstoff. In some cases, the wording of the liquidated damages clause may be so close to the wording in Glanzstoff that the House of Lords’ decision is binding. That is a decision of our highest court, which has never been disapproved.”
The “Greenore” approach
This approach is generally treated by the textbooks as the orthodox approach. It is based on the view that an employer’s accrued rights under the contract should be preserved even if it wishes to terminate the contractor’s employment, and that in addition, it should be entitled to claim general damages for any period of post-termination delay to the completion of the works.
However, Sir Rupert Jackson observed that this approach is “not free from difficulty”, and expressed the view that the employer’s right to apply LADs up to the date of termination (and possibly beyond) will depend on the specific wording of the clause. He noted that in circumstances where the LADs clause does provide for the situation where a contract is abandoned or terminated it may be artificial and inconsistent with the parties’ agreement to categorise the employer’s losses as being £x per week up to a specified date (the termination date) and then general damages thereafter.
The “GPP and Hall” approach
Under this approach, the contractor will be bound to pay LADs up to the point in time when any replacement contractor has achieved completion. The rationale for this approach appears to be that if the contractor was not bound to pay LADs it may benefit from its own default. Whilst conceptually, this approach would seem to have merit (and indeed has received judicial support), in that it seeks to uphold the terms of the bargain agreed by the parties, it does raise problems in that the period for which the original contractor may be liable for LADs will be entirely outside of its control, and may end up being prolonged by delays which are of the replacement contractor’s making.
Recognising these problems, Sir Rupert Jackson expressed his doubts about this approach, noting that
“if they are correct, it means that the employer and the second contractor can control the period for which liquidated damages will run”.
Comment
As to which approach will be applicable, the Court of Appeal emphasised that much will turn on the precise wording of the LADs provision. However, whilst there remains no single definitive approach, the decision in Triple Point has confirmed that where a provision makes clear that LADs will be payable up to the date of completion (and it is worth noting that a number of contracts are drafted in this way, including JCT and FIDIC forms), termination or abandonment of the contract prior to completion will result in the entitlement to claim or deduct LADs falling away entirely.
However, as was indicated by Sir Rupert Jackson, this would not leave the employer without a remedy for non-completion. Rather, damages will be “at large”, meaning the employer would be entitled to claim general damages incurred as a result of the delay. Therefore, in giving this judgment, the Court of Appeal has brought the approach adopted in a largely forgotten House of Lords’ decision back into the spotlight, and cast a shadow over the other two accepted approaches.
Where does this leave contractors and employers? In the event of termination, the contractor may find that the certainty provided by the predetermined level of damages (a risk for which it is likely to have provided) falls away only to be replaced by a potentially much greater liability for general damages. From the employer’s perspective, whilst it may offer the potential for a higher level of recovery (in the event the actual damages are greater than the pre-agreed level of LADs), the employer will be faced with the burden of having to prove its entitlement to such damages which may be time consuming and costly. For both parties, the prospect of getting drawn in to potentially costly and protracted legal proceedings will be an unwelcome one.
Therefore parties would be well advised to give proper consideration to the meaning and effect of the LADs and termination provision in their contract, and the potential implications of termination on the ability to deduct or claim LADs, before any decision is taken to terminate or abandon a contract which has not achieved completion but where the contractual date for completion has passed.
As to the negotiation of new contracts, this case underlines the point that precise drafting of LADs (and termination) provisions is essential. Therefore, for all new contracts, parties will need to consider carefully how they wish LADs to apply in the event the contractor’s employment under a delayed contract is terminated, and to ensure their intentions are accurately reflected in the written agreement.