Those in the building and construction industry are likely to come across the term “liquidated damages” in their construction contracts. This article will explain liquidated damages in construction contracts and provide an example of its application in a recent case Spiers Earthworks Pty Ltd v Landtec Projects Corporation Pty Ltd (No 2) [2012] WASCA 53 (‘Spiers’). 

The distinction between liquidated damages and general damages is that the former is a fixed rate or amount in the contract between the parties, whereas the latter is an amount determined by a court when it hears the matter.

You can find liquidated damages clauses in many contracts, not just those in the construction industry. They can be used to claim compensation for various breaches of a party’s obligations under the contract. For construction contracts, the parties will likely claim this type of damage where there are substantial delays, and the contractor fails to meet the practical completion date.

Why Have Liquidated Damages Clauses?

Liquidated damages clauses operate to incentivise each party to complete their obligations under the contract on time. The principal can recover their loss without having to prove their actual loss, and the contractor will have certainty that the contract will cap their liability for damages at a certain amount.

The parties will usually agree to the liquidated damages clause before signing a contract. So, a court will enforce the provision, as each party is expected to hold up their end of the bargain. However, there are limits on the enforceability of liquidated damages clauses.

Enforceability of Liquidated Damages Clauses

The key consideration with liquidated damages clauses is whether or not the amount specified in the contract amounts to a penalty. If the court finds that the clause imposes a penalty on the party in breach, the court will not enforce the clause.

For the clause to be enforceable, the damages specified must represent a genuine pre-estimate of loss that the aggrieved party is likely to suffer as a result of the other party’s breach. This amount is calculated at the time of entering into the contract.

It is recommended that the liquidated damages clause includes a formula for calculating the damages, accruing at fixed intervals (e.g. daily). The parties should not use a lump sum amount unless the circumstances are such that the parties can calculate the amount accurately and easily.

When Will the Amount of Liquidated Damages be Considered a Penalty?

In the English case of Dunlop Pneumatic Tyre Co Ltd v New Garage & Motor Co Ltd [1915] AC 79 (‘the Dunlop Case’), the Court noted that whether a sum stipulated is a penalty or enforceable liquidated damages will depend on the circumstances of each contract. The court then went on to list a number of useful tests that aid the assessment. To summarise, a sum will be a penalty if:

  • The amount is extravagant and unconscionable when compared to the greatest loss that flows from the breach;
  • The breach is solely for non-payment of a sum of money, and the amount the aggrieved party is trying to claim exceeds the sum that should have been paid; and
  • The amount is a single lump sum payable on the occurrence of one or multiple events which vary in seriousness, with some only warranting trivial damages.

These tests will not be definitive. The court made clear that just because it is not possible to pre-estimate the actual loss that a party may suffer does not mean a liquidated damages clause will automatically amount to a penalty.

The Australian High Court approved the Dunlop case in Ringrow Pty Ltd v BP Australia Pty Ltd [2005] HCA 71 (‘Ringrow’). In Ringrow, the Court noted that a key factor in determining whether liquidated damages are extravagant and unconscionable is whether the amount the aggrieved party is claiming is ‘out of all proportion’ with the loss they are likely to suffer.

What this shows is that a liquidated damages clause will not be unenforceable simply because there is some difference between the value of a liquidated damages clause and a genuine estimate of loss. Rather, it must be totally disproportional.

Recent Case: Spiers Earthworks v Landtec Projects Corporation

In Spiers, the Court considered a liquidated damages clause in a development contract. The developer was to subdivide the land and had authority to do so from the Council on certain conditions. One condition required improvements to a road before any subdivision and sale occurring.

The developer initially contracted with Spiers to do construction work, but not to complete the road improvements. Practical completion was subsequently delayed by two months. It wasn’t until after that time that the developer engaged Spiers to do the road works.

The initial contract contained a liquidated damages clause. The liquidated damages clause provided a weekly rate of $13,846 per week, accruing daily from the date set for practical completion up to and including the actual date of practical completion.

Spiers argued this was a penalty and therefore unenforceable. Their argument was because any delay of practical completion was due to the developer’s failure to have the road improvement works completed by practical completion.

The Court’s Decision

In concluding that the clause did amount to a penalty, the Court looked at the fact that the estimate of damage was a formula based on the expected sale price of the subdivided lots. This formula was not a genuine pre-estimate of loss flowing from the contractor’s failure to complete the works on time.

Additionally, the developer had shown no actual intention of complying with the council condition requiring road improvements before the date of practical completion. The sale of the lots was dependent on this occurring. Therefore a delay in reaching practical completion could not have caused any financial loss to the developer until the condition had been satisfied or otherwise waived by the council.

Key Takeaways

You should draft liquidated damages in construction contracts in a way that reflects a genuine estimate of a party’s foreseeable loss directly flowing from the other party’s default. This amount will be particular to the circumstances of the project, and the parties should calculate it by using a fixed formula.

If you are a party to a construction contract (or any other contract) that contains a liquidated damages clause, you should always consult a lawyer and get advice on your legal standing. LegalVision can assist you with drafting your contract, and provide practical ways to avoid having any part of your contract unenforceable. Get in touch with our construction lawyers today on 1300 544 755.

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