Liquidated damages: commercially justified, not a penalty

Some significant issues in relation to the application of liquidated damages for delay have been considered in the recent case of GPP Big Field LLP & Anor v Solar EPC Solutions SL (2018).

GPP Big Field LLP and GPP Langstone LLP (together and separately “GPP”), as employer, entered into five EPC contracts with Prosolia UK Limited (“Prosolia”), the contractor, for the construction of solar power generation plants in the UK. The terms of the five EPC contracts were substantially the same.

Solar EPC Solutions SL (“Solar”), was the contractor’s parent company. Solar guaranteed the obligations of the contractor under four of the EPC contracts.

Under each EPC contract, GPP claimed liquidated damages for Prosolia’s failure to commission each plant by the date specified in the relevant contract. In March 2014, Prosolia became insolvent and as a result, GPP claimed against Solar under the guarantees.

Two key issues arose:

• was the liquidated damages provision in each EPC contract an unenforceable penalty?
• do liquidated damages continue to accrue after termination?

Were the liquidated damages an unenforceable penalty?

Solar argued that the liquidated damages provision was a penalty because:

• the liquidated damages clause itself referred to the amount as a “penalty”;
• the same rate of liquidated damages (£500 per day per MWp) had been specified in each EPC contract even though each plant had a different output and there was a difference of over 30% in the expected electricity prices recorded in the various contracts; and
• there had been no detailed negotiations to ascertain the appropriate level of liquidated damages.

Whilst the judge found there probably had not been detailed negotiations in relation to the rate of liquidated damages, the liquidated damages provision was not a penalty and was enforceable because:

• GPP and Prosolia were experienced and sophisticated commercial parties of equal bargaining power and were able to assess the commercial implications of the liquidated damages clause;
• the fact that a round figure had been used, that might not match up to the actual loss incurred in any circumstances, are common in construction contracts;
• in Cavendish Square Holdings B.V. v Makdessi and ParkingEye Ltd v Beavis (2015), the test was whether the clause was “out of all proportion to any legitimate interest of innocent partyin the enforcement of the primary obligations” and/or whether the sums stated were “extravagant, exorbitant or unconscionable”. In applying the recent Supreme Court decision, the judge decided that the sum was commercially justified on the basis that:
  • a. the liquidated damages rate did not exceed a genuine attempt to estimate in advance the loss which GPP would likely suffer from a breach and that sum was “not extravagant or unconscionable” in comparison with the legitimate interest of GPP in ensuring timely performance; and
  • b. in two of the EPC contracts, the start period for paying liquidated damages was expected to be during the summer months which was the height of the peak generation period for solar power generation plants. Accordingly, the court held that the figure of £500 per day per MWp was not an exorbitant or unconscionable estimate of the likely loss caused by any delay in commissioning the plant; and
  • c. it was the substance of the matter that was important, not the reference to a penalty.

Do liquidated damages accrue after termination?

One of the EPC contracts was terminated by GPP prior to commissioning being achieved. Solar argued that its liability for liquidated damages ended when GPP terminated the contract. However, GPP argued that the liquidated damages provision continued to apply until commissioning was achieved using alternative contracts.

In reliance on Hall and another v Van den Heiden (No 2) (2010), the court held that liquidated damages survived termination of the contract. In Hall it was held that an interpretation which brought liquidated damages to an end upon termination would otherwise reward the defendant for his own default.

It should be noted that, even given the decision in Hall, the common view remains that liquidated damages would not be payable after termination. This is because at termination the contractor loses control of the time for completion, especially if another contractor is employed to complete the works. The contractor will be liable for the cost of completing the works and other losses and expenses of the employer arising from termination in accordance with the express terms of the building contract.

Implications

This case confirms that in a negotiated contract between properly advised parties with comparable bargaining power, it is the parties themselves who are the best judges of what is legitimate in a liquidated damages provision dealing with the consequences of a failure by the contractor to complete the works by the date for completion as specified in the contract.

In determining what constitutes a penalty, Employers should ensure the rate of liquidated damages can be commercially justified and the relevant tests are whether it is a “genuine pre-estimate of loss” and if the sum agreed is likely to be out of all proportion to the greatest loss likely to be suffered.

Finally, the court’s decision as to liquidated damages continuing to accrue post-termination is controversial and this issue is likely to necessitate resolution by the Court of Appeal in the future.