FAILURE TO RECOVER COMPENSATION DESPITE LIQUIDATED DAMAGES CLAUSE IN CONSTRUCTION CONTRACTS

Construction contracts normally also have a clause providing for recovery of damages from party-at-breach by the suffering party to compensate the latter for the loss incurred by it on account of the breach of contract by the other party.

The relevant clause of the contract may either provide for recovery of an amount as reparations for the breach of contract, either as a pre-determined amount (Liquidated Damages) or may provide for payment of a sum that shall be determined as per actual losses suffered (Unliquidated Damages).

Fundamentally, the Liquidated Damages (‘LD’) refer to the genuine pre-estimate of losses estimated to be suffered by the other party upon breach by the party-at-breach. The Unliquidated Damages (‘ULD’) refers to the reparations payable as per actual loss suffered which amount will be determined after the breach, as per actuals.

Referred to as “LD” in short, the term is commonly misunderstood to be a blanket guarantee for enabling huge and even unfair recoveries from the party at breach. Given that most public works projects are one-sided, the “LD clauses” are designed to be extortive i.e. framed in a way so as to blackmail the contractors for extracting large sums of money from them upon occurrence of the event of breach, which determination/adjudication is also vested in the Engineer Incharge appointed by the employer. Failure to understand the enforceability and extent of liability under the LD clause causes weaker party in the one-sided contract to accept unfair terms & weighty directions of the other party, to avoid their own small & routine latches/failures from being adjudged as breach thereby leading to large claims under liquidated damages clause of the contract.

However, merely providing an LD clause is no assurance that the sum stated therein can even be recovered fully or even recoverable. There are a variety of aspects that need to be considered and redressed both at the time of drafting the LD clause, and at the time of raising a claim for LD.

I.??????????????????? SOME OF THE MISTAKES/MIS-CONCEPTIONS ARE AS FOLLOWS:

First, failure to incorporate an LD clause altogether, or a lackadaisical approach in framing an effective and enforceable LD clause can result in absolute denial of any amount whatsoever as the damages under the LD clause. ?

Second, however, the way this concept is worded in the statutes and exacerbated by the way it is taught in schools, it is generally misunderstood that for damages recoverable under liquidated damages clause, no proof of the actual damages suffered has to be given or that any absurd amount even disproportionate to the scale of consequent / anticipated/actual loss can be specified therein or be recovered.

Third, there is another misconception that the sum payable/recoverable shall be exactly the sum already fixed in the clause – neither less nor more. Since the pre-fixed sum stated therein is deemed to have been agreed by both parties since the contract has been executed in writing, and therefore the party at breach is assumed to be bound by estoppel and hence presumed to be precluded from claiming the amount to be exorbitant or extortionist.

Fourth, there is sometimes also a confusion as to what is the sum recoverable when the actual losses are much more or much less than the pre-determined amount stated in the LD-clause.

Fifth, the claimant assumes or ignores a legal role of claimant himself - the roster of responsibilities and burdens cast on the claiming party under the law of damages. A claimant of contractual damages is supposed to be diligent & proactive at the time of happening of the event of breach of contract and even required/mandated to take certain steps after that

II.????????????????? Let us look at the issues that must be understood when having decided that the damages shall be a pre-fixed sum and it is a stage of framing an LD-clause

First, trigger events entitling a claiming party to raise a claim for damages must be defined very objectively and must be unambiguously incorporated in the contract. The very determination of the occurrence of event or whether the event actually constitutes a trigger under the damages clause prolongs disputes and their adjudication even in Courts or Arbitrations;

Second, any LD clause must be named as such and not by any fancy phrase. Alternately, the clause may begin with a declaration that its prescriptions are in terms of s. 74 of Indian Contract Act which govern situations where sums payable as compensation for breach are stipulated in the contract itself;

Third, the LD clause must also provide for a fixed sum of money either in currency value or as % of contract value or other conventions acceptable in local customary practices of the trade, as being payable by party-at breach upon determination/occurrence of such breach. A vague formulae or description of compensation, attempting to derive the value that’s indeterminate or proved to be so, may defeat the claim;

Fourth, it must be understood that Liquidated Damages clause does not dispense with the need for claiming party to prove actual losses having been suffered. Even the LD-clause enables recovery without proof of actual losses ONLY where it is difficult/disproportionately-cumbersome or infeasible (due to technical or other reasons) to determine the actual losses - that is only where actual losses suffered cannot be proved;

Fifth, the pre-fixed amount (or %-age of contract amount) must be a genuine pre-estimate of losses and anything seen as a form of penalty may invalidate the LD clause itself. An unsupported prescription without any analysis to back-up the stated amount shall render it to absolute discretion of the Court (or Arbitral Tribunal) to determine the amount payable;

Sixth, even where the LD clause is not held as a “penalty clause” and where it is not possible to determine actual losses as a direct (not too remote) result of the breach, the amount of damages actually determined to be payable may be very different from the pre-determined sum on account of latches attributable to the claiming party in preventing any portion of losses, or not being proactive in taking steps to undo the losses suffered through other means where they are available, and still further there might be other losses which may be seen as being too remote to be attributable to the breach.

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