Background

In the UAE, your liability to pay agreed damages is an obligation ancillary to the primary obligation of performance of the conditions in a contract. In other words, the liability arises only after a breach of a performance obligation.

An agreed damages clause has 2 parts. First is the primary obligation for the contractor to complete the works in time.  The other part is to pay agreed damages for breach of the obligation of the first part.

It has been the approach of the UAE courts to disregard the secondary obligation to pay agreed damages if the primary obligation is annulled by way of termination of the contract.

Therefore if a construction contract is terminated, the agreed damages clause may be ineffective and the employer may then claim general damages based on tortious liability i.e. actual loss sustained without regard to the agreed damages.

The Courts have previously taken the view that agreed damages are deemed to be a penalty clause which is a secondary obligation correlated to the primary obligation, and it is a forfeit to the breach of the latter. The ineffectiveness of the primary obligation – as a result of the contract termination – leads to the ineffectiveness of the penalty clause. It follows that the Courts should not take account of the agreed damages stated in  award general damages.

Recent Case Refines the Law

The recent decision of Abu Dhabi Court of Cassation (Court) [Commercial Appeal 790 of 2013 (dated 22 October 2014)] (Decision) potentially alters the existing position of law as regards delay damages.

In the Decision, the Court held that termination does not always prevent the application of agreed damages clause. As long as the agreed damages clause is an independent clause which the parties have agreed will survive termination, it will be effective after the termination of the contract.

The Change

The decision is a change from the Court’s earlier view that agreed damages clauses did not survive termination of a contract (in which case a party could only rely on tortious liability for claiming damages rather than contractual liability).

If you want to have agreed damages and use an unamended FIDIC contract, you may find that your clause does not survive termination if it is considered by a UAE court.

As a contractor you may find that your previously capped risk is now open ended without any regard to the agreed rate.

As an employer or main contractor you may find that you now have to prove your damages as a tortious claim.

Are You Prepared?

To ensure your agreed damages clause survives termination, carefully drafted amendments need to be made to it in light of the Court’s decision. This is especially important for employers who want to claim liquidated damages after the termination of a contract (which is more often than not the case).