Liquidated damages clauses are commonly found in construction contracts making provision for the contractor to pay liquidated damages to the client in the event that the contract is breached.  A recent High Court case has considered when such clauses amount to unenforceable penalties.

GPP Big Field LLP v Solar EPC Solutions

A number of EPC contracts were entered into for the construction of solar power generation plants. Each contract contained a liquidated damages clause. The contractor became insolvent and the employer sought to claim liquidated damages against the contractor’s guarantor for the delays in commissioning the plants. The guarantor argued, amongst other things, that the liquidated damages clause was an unenforceable penalty because (i) the clauses were described in the contracts as a ‘penalty’; and (ii) a single rate of liquidated damages applied under each of the contracts, despite the fact that the loss that the employer would suffer would not be the same for each plant.

What does the law say?

The Courts will not uphold a clause that is intended to simply punish a party in default. Historically, the test applied by the Courts for determining whether a liquidated damages clause was penal in nature was whether the rate of damages was a genuine pre-estimate of loss. That test has now been expanded, meaning that it is no longer simply a question of whether it is a genuine pre-estimate of loss; the Courts will now also consider whether there is some other commercial justification.

What the court decided in this case

The Court held that:

  1. The fact that the parties had described the clauses as a ‘penalty’ was not determinative;
  2. Whilst the sum specified was not a precise calculation, it did not exceed an genuine attempt to estimate in advance the employer’s losses; and
  3. The sum was not extravagant or unconscionable in comparison with the legitimate interests of the employer in ensuring the project was completed on time.

Courts are reluctant to strike out liquidated damage clauses

The case serves as a useful reminder that the Courts are reluctant to strike out liquidated damages clauses where the terms have been the subject of negotiation between parties of equal bargaining power and that it is no longer simply a question of whether the liquidated damages is a genuine pre-estimate of loss. However, parties must still ensure that the liquidated damages clause is not extravagant or disproportionate to the potential losses that would be suffered.