Liquidated Damages in the UAE: A Legal Perspective

I. Introduction

In the dynamic legal and business landscape of the United Arab Emirates (UAE), liquidated damages play a pivotal role in ensuring the fulfillment of contractual obligations. This article aims to provide an understanding of liquidated damages, their legal framework, and practical implications within the UAE.

II. Definition of Liquidated Damages

Liquidated damages are pre-determined sums specified within a contract, payable upon a breach by one of the parties. These damages are intended to provide a fair estimation of potential loss or damage that could occur due to non-performance or delayed performance, thereby circumventing the need for judicial assessment.

III. Legal Framework in the UAE

In the UAE, the concept of liquidated damages is governed by the UAE Civil Code (Federal Law No. 5 of 1985). Pursuant to Article 390 of the UAE Civil Code, contracting parties are permitted to agree in advance on the amount of compensation for damages that may result from non-performance or delayed performance of contractual obligations. However, the courts retain the authority to adjust the agreed-upon amount if it is deemed to be excessively high or if the actual damages incurred are significantly lower.

Article 390 stipulates that:

“1- The contractors may determine in advance the value of compensation by stipulating it in the contract or in a subsequent agreement, subject to the provisions of the law.

?2- In all cases, the judge may, at the request of one of the parties, amend this agreement to make the assessment equal to the damage and void any agreement that violates this.”

IV. Practical Implications in Construction Contracts

In the context of construction contracts within the UAE, liquidated damages extend beyond mere penalties for delays. They encompass fines and housekeeping charges for breaches of site regulations and safety protocols. This legal mechanism ensures compliance and accountability across various facets of construction project management.

V. Enforceability of Liquidated Damages

The enforceability of liquidated damages, particularly when no tangible loss is incurred by the employer, is governed by specific provisions in the UAE Civil Code. Article 390 provides the legal framework for the imposition and modification of liquidated damages:

1. Pre-Determination of Damages: Contracting parties may stipulate in advance the amount of liquidated damages, either within the contract itself or through a subsequent agreement.
2. Judicial Discretion: A judge is vested with the authority to adjust the stipulated liquidated damages to ensure they correspond with the actual harm suffered.

VI. Judicial Discretion and Practical Implications

The discretionary power conferred by Article 390 introduces a degree of unpredictability regarding the enforceability of liquidated damages. UAE courts possess the authority to adjust the agreed-upon damages to match the actual loss, potentially overriding any contractual caps on liability. This includes the possibility of increasing the liquidated damages if the actual loss exceeds the pre-agreed amount. However, in practice, the courts exercise this discretion judiciously.

Article 390(2) entitles either party to a contract to request an adjustment in the compensation. The court can decrease or increase the liquidated damages specified in the contract. This concept, particularly the employer's right to seek an increase in liquidated damages, may be unfamiliar to those from common law jurisdictions. The Civil Code does not specify the precise circumstances under which the court may exercise this discretion, but it may consider principles from the Egyptian Civil Code, which heavily influences the UAE Civil Code.

VII. Judicial Precedents

Case No. 428/2010 - Federal Supreme Court

The ruling established that delay penalties in private construction contracts are considered as liquidated damages when the contractor fulfills their obligation. It emphasized the necessity of conditions such as fault, damage, and causation. Furthermore, in accordance with Article 390 of the Civil Code, it affirmed that contracting parties may pre-determine compensation value in the contract or a subsequent agreement, subject to legal provisions. The court is empowered to amend such agreements to ensure the damages equal the actual harm, voiding any agreements that contradict this principle.

Case No. 433/2018 - Court of Cassation (Dubai)

This judgment articulated that a penalty clause in a contract is essentially a form of liquidated damages. Although such an agreement presupposes the occurrence of damage upon breach, it does not negate the requirement for evidence of actual harm suffered. As per Article 390 of the Civil Code, parties may pre-determine the compensation amount in the contract or a subsequent agreement, respecting legal provisions. The existence of a penalty clause presumes damage upon its activation, shifting the burden of proof (onus probandi) to the debtor to demonstrate that no harm occurred or that the compensation is disproportionate to the actual damage.

VIII. Opinion on Judicial Precedents

The judicial precedents highlighted underscore the UAE judiciary's balanced approach to liquidated damages, ensuring that these clauses serve their intended purpose without resulting in unjust enrichment. The Federal Supreme Court's ruling in Case No. 428/2010 aligns with the principle of bona fide dealings, requiring proof of fault, damage, and causation, thereby reinforcing the need for equitable compensation. This decision ensures that liquidated damages are not merely punitive but reflective of actual losses incurred.

Similarly, the Dubai Court of Cassation's decision in Case No. 433/2018 underscores the importance of substantiating claims for liquidated damages with tangible evidence of harm. By shifting the onus probandi to the debtor, the court ensures that the enforcement of penalty clauses is grounded in reality, preventing potential abuse of pre-determined compensation amounts. This approach promotes prima facie fairness in contractual relationships, ensuring that the compensation awarded is commensurate with the actual damage suffered.

IX. Defenses to Liquidated Damages Claims

Defenses against an employer's claim for liquidated damages may arise under the contract terms or UAE law. Contractual defenses include:

• The works were completed in accordance with the contract requirements, and/or the employer has taken possession or is using the works.
• The employer has improperly withheld the completion certificate.
• The contractor is entitled to an extension of time.
• The formula for calculating liquidated damages in case of delay is inoperative.

Under the UAE Civil Code, additional defenses may include:

• The contractor is not liable for project delays due to force majeure events, provided the contract does not state otherwise.
• Both the employer and the contractor share responsibility for delays, which may provide grounds for the contractor to seek relief.
• The liquidated damages should be adjusted to equal the actual loss suffered by the employer.

However, The burden of proof (onus probandi) ?lies with the party seeking the adjustment. Typically, this will be the contractor, who must provide evidence demonstrating that the employer's actual loss is less than the stipulated amount. Conversely, if the employer's loss exceeds the stipulated damages, the employer must present evidence to justify an increase. The courts will assess claims and defenses with an emphasis on In good faith (bona fide) dealings between the parties. Both parties are expected to act in good faith throughout the contractual process, including in the negotiation and enforcement of liquidated damages clauses.

Further to that, at a prima facie level, courts will scrutinize the liquidated damages clauses to ensure they are not punitive in nature but rather a genuine pre-estimate of loss. This initial assessment forms the basis upon which further judicial scrutiny and adjustments may be made.

X. Key Considerations

1. Clarity and Precision: The liquidated damages clause should be articulated with clarity and precision within the contract to obviate any ambiguity. This ensures that both parties are fully apprised of their obligations and the consequences of any breach.
2. Reasonableness: The stipulated amount should represent a reasonable estimate of potential loss. Courts in the UAE may reduce liquidated damages deemed excessive to align with actual losses, thereby ensuring fairness.
3. Proof of Loss: Although liquidated damages are pre-agreed, demonstrating a nexus between the breach and the stipulated amount can fortify the enforceability of the clause.
4. Mitigation of Loss: The non-breaching party is typically expected to undertake reasonable steps to mitigate their losses. Failure to do so may impact the amount of compensation recoverable.

XI. Conclusion

The legal framework surrounding liquidated damages in the UAE, as governed by the Civil Code, reflects a balanced approach that prioritizes fairness and actual loss assessment. While contractual autonomy is respected, the judiciary retains discretionary power to ensure equitable outcomes, adjusting damages when necessary to align with the true harm suffered.

The concept of liquidated damages under UAE law, including the ability to adjust amounts and the availability of defenses, underscores the importance of clear and well-structured contracts. Parties entering into agreements in the UAE should be cognizant of these nuances to ensure compliance and effective dispute resolution.

Overall, the UAE’s legal system provides a robust framework for addressing liquidated damages, promoting accountability, fairness, and adherence to contractual obligations within the construction industry and beyond.