In April last year I wrote an article about the case of Cavendish Square Holdings v El Makdessi, which introduced a new approach to the issue of whether a liquidated damages (“LDs”) clause in a contract would be upheld as having commercial justification, or whether the clause would be struck out as being an unjustifiable penalty.
The law on this subject has now developed further, in the light of the recent decision in the case of Unaoil Ltd v Leighton Offshore Ltd. The relevant facts are quite complicated.
Leighton and Unaoil got together to bid for a US$700 million oil project in Iraq, with Unaoil to act as sub-contractor to Leighton. To this end, Unaoil and Leighton entered into a memorandum of agreement (MOA) for the Phase 1 works. The price under the MOA was US$75 million, made up of around US$35 million for engineering works and US$40 million for “support services”. The contract provided for a non-refundable advance payment of 15% of the fee and LDs of US$40 million if Leighton was awarded the main contract but breached the terms of the MOA. However, the MOA indicated that Unaoil would still provide the “support services” in these circumstances.
Subsequently, the MOA price was negotiated down to US$55 million.
In the events which transpired, Unaoil claimed US$52.5 million in damages for a US$55 million contract under which it appeared no work had ever been carried out.
Unsurprisingly, Leighton argued that the US$40 million LDs were penal. The judge, noting that the US$40 million equated to the US$40 million value attached to the “support services” that Unaoil was to provide irrespective of whether Unaoil got the sub-contract, stated that he was content to assume that the US$40 million figure was a genuine pre-estimate of loss when the MOA was signed.
However, it is at this point that the judge departed from the usual track and went on to say:
“I … fully accept what is trite law i.e. that the question whether the clause is a penalty or not must be viewed as at the date of the contract. However, where, as here, the contract is amended in a relevant respect, the relevant date is, in my judgment, the date of such amended contract … Here, once the original contract price was reduced … the figure of US$40 million was, even on Unaoil’s own evidence, manifestly one which could no longer be a genuine pre-estimate of likely loss by a very significant margin indeed …”
The judge then went on to assess Unaoil’s actual losses – an interesting exercise in itself, given that it involved assessing the cost of providing the rather nebulous “support services” that neither party was able to either satisfactorily describe, let alone cost.
The idea that a material amendment to a contract could result in the agreed LDs no longer being a genuine pre-estimate of loss sounds eminently sensible. If LDs are based on the loss of rent from 10,000 sq m and the contract is varied to halve the project to 5,000 sq m, then it would seem unfair not to revisit the LDs.
While this approach is superficially attractive, it could cause difficulties in the future. If the reassessment of LDs is to be applied whenever the contract is “amended in a relevant respect”, then most current forms of building contract would become unworkable.
Chris Harper is a partner and head of the dispute resolution team in Exeter. He specialises in commercial litigation and is named as a leader in his field by independent guides to the legal profession Legal 500 and Chambers. To contact Chris please call 01392 210700 or email firstname.lastname@example.org.