TBB 2016.541 Modification of arbitration case law regarding an employers' right to charge daily penalties for actionable delays in respect of interim key dates

The Building and Construction Arbitration Board has issued a ruling, which was recently published in the Danish Journal for Right of Occupation and Construction Law 2016, p. 541 (in Danish: Boligog Byggeret). The ruling regards daily penalties charged in respect of interim key dates (in Danish: mellemterminer) in a contract awarded on a trade-by-trade basis (in Danish: fagentreprise). The arbitration tribunal decided that the employer was entitled to charge daily penalties for exceeding an interim key date in the amount of approximately DKK 12 million in total, out of a total contract sum of approximately DKK 37.7 million. However, the total amount of the daily penalties was reduced on a discretionary basis by the arbitration tribunal to DKK 9 million due to the fact that the contractor accelerated the works which reduced the delay of the interim key date in question. Moreover, the contractor reduced the delay of the completion date.

According to arbitration case law a distinction is made between interim key dates and partial completion deadlines. Interim key dates constitute a sanction for late performance and are meant to create an incentive for the contractor during the contract process to respect all deadlines sanctioned by daily penalties thus allowing the employer to raise a claim for daily penalties if any delays occur during the process, even if the entire contract work is completed on time1. Interim key dates represent specifications of deadlines defining the dates of completion for certain important activities2. The new ruling regarding daily penalties charged in respect of interim key dates will be reviewed below.

Partial completion deadlines (in Danish: delfrdiggrelsesfrister) are deadlines, which do not impact on the performance of other activities but do impact on the employer's interest in being able to dispose of the completed parts of the contract in due time. Partial completion deadlines will be addressed in the end of this newsletter.

The general rule according to arbitration case law

In the KFE 1996.47 ruling, the arbitration tribunal expressed four cumulative conditions for charging daily penalties, when interim key dates are exceeded:

  1. There must be a clear and unambiguous legal basis for the interim key dates triggering daily penalties
  2. The interim key dates in question must concern crucial activities
  3. Exact records must be kept of the delays of the interim key dates less any extension of time, and
  4. Very special circumstances must prevail, which can justify daily penalties for a larger amount than the amount corresponding to the final delay of the completion of the contract.

Modification of the general rule regarding contracts awarded on a trade-by-trade basis ruling published in TBB 2016.541

In this arbitration tribunal ruling, an employer and a contractor had entered into a contract based on the terms of the Danish General Conditions for the provision of works and supplies within building and engineering (AB 92) with some further specifications and deviations providing that the contractor was to perform a building and shell construction contract. The total contract sum was approximately DKK 37.7 million. The contract was one out of several contracts awarded on a tradeby-trade basis, which the contractor had entered into. The parties to the agreement had agreed upon a daily penalty of 2 of the total contract sum equivalent to DKK 75,480 for each calendar day that the contractor was guilty of actionable delay, including delays of milestones, which were placed at crucial points in the time schedule. According to the contract, the daily penalties for actionable delay of previous milestones would not lapse with the handing-over of the contract on the completion date.

Delay arose in relation to several key dates. However, the employer only charged daily penalties for the key date, which was delayed the most.

The contractor argued that the daily penalties only fall due, when it has been definitively ascertained that the contractual completion date is exceeded, and that the employer was not entitled to set off the claim for daily penalties without special agreement or withhold amounts against the contractor's requests for on account payments even though milestones were exceeded. Furthermore, the contractor argued that the conditions according to arbitration case law for charging daily penalties when interim key dates are exceeded were not fulfilled.

As a starting point, the arbitration tribunal found that the employer was entitled to charge daily penalties when interim key dates were exceeded, including that an agreement existed providing for daily penalties when crucial points specified in the time schedule were exceeded, and that the employer had recorded and hereby documented the delays in respect of the key dates subject to daily penalties.

The arbitration tribunal further stated:

"The arbitration tribunal finds that the use of daily penalties when interim key dates are exceeded can be justified in a contract as the one at hand which includes several contracts awarded on a trade-by-trade basis, where the work concerns a complex construction, which is being performed within a confined physical space and where delays with one contract awarded on a trade-by-trade basis can have immense consequences for the other entrepreneurs work and the economic relationship between these contractors and the employer" (our underlining).

The employer had recorded 214 penalty days, and after the arbitration tribunal had awarded a 55days extension to the contractor, the employer's claim for daily penalties was quantified to 159 days. Fundamentally, the arbitration tribunal awarded the employer an overall claim for daily penalties of approximately DKK 12 million. The arbitration tribunal did not find that the claim for daily penalties, which represented a significant part of the contract sum, could be disregarded pursuant to section 36 of the Danish Contracts Act or otherwise contributed to an unfounded enrichment of the employer. However, the arbitration tribunal found that the contractor had accelerated the works, which meant that the delay of the interim key date in question forming the basis of the claim for daily penalties was reduced. Simultaneously, the delay in regard to the completion date was equally reduced which benefitted the employer. Subsequently, the employer's total claim for daily penalties for the interim key date was reduced on a discretionary basis to DKK 9 million by the arbitration tribunal.

Comments on the ruling

Based on the arbitration tribunals reasoning, it can be concluded that the conditions set forth in arbitration case law for charging daily penalties on interim key dates are still used today as a general rule. In this case, the arbitration tribunal found that there was an agreement where both the size of the daily penalty and the relevant milestones appeared, and that it also appeared in the agreement that handing-over on the completion date did not lead to the lapse of daily penalties for previous milestones. The conditions for daily penalties and the relevant milestones were furthermore adequately described in the tender material. The milestones were placed on crucial points in the time schedule, and finally the employer had registered every day that gave rise to daily penalties.

The arbitration tribunal emphasised the conditions stipulating that 1) there must be a clear agreement; 2) the interim key dates must relate to crucial activities; and 3) there must be made accurate recordings.

Furthermore, the decision clarifies the fourth condition regarding the so called "special circumstances". It can be derived from the decision that it can constitute a special circumstance, when a contract is awarded on a trade-by-trade basis, where the work regards a complex construction which is being performed within a confined physical space and where delay can have immense consequences on the financial relationship between the employer and the contractor.

What is more, the decision emphasises that a total claim for daily penalties of about 32 % of the total contract sum is not inconsistent with section 36 of the Danish Contracts Act but the claim for daily penalties was reduced due to the reasons mentioned.

The decision regards a contract awarded on a trade-by-trade basis, and the arbitration tribunal emphasises that delay with one contract awarded on a trade-by-trade basis may impact immensely on other contract work. This means that the decision has limited value in terms of precedence regarding turnkey projects and main contracts (in Danish: total- og hovedentreprise). Depending on the circumstances, the decision can have value in terms of precedence for multi-trade contracts (in Danish: storentreprise).

Finally, it should be noted that there was an actionable delay with regard to the completion date, and it is therefore uncertain whether the arbitration tribunal would have acknowledged the employer's right to charge daily penalties in respect of interim key dates if the completion date had not been delayed.

Partial completion deadlines

According to arbitration case law a distinction is made between interim key dates and partial completion deadlines. Partial completion deadlines do not impact on the performance of other activities but do impact on the employer's interest in being able to dispose of the completed parts of the contract in due time.

In its ruling in the KFE 09.245 VBA case, the arbitration tribunal found that daily penalties regarding delayed completion of a show apartment did not qualify as daily penalties for exceeding an interim key date in the building project. The purpose of the daily penalties were to ensure that the employer would be able to present an apartment in reasonable time before the completion of the building project, and thereby make sure that the apartments could be leased from the time where the building could be utilised as a property for rental purposes.

In the ruling KFE 11.038, the parties had agreed that the renovated bathrooms were to be assigned to the occupants in one building unit at a time, and if the deadlines were exceeded, it could trigger a daily penalty. The arbitration tribunal found that it could not be ruled out that the daily penalties had been determined out of consideration for the occupants' convenience, however, the daily penalties also served to ensure the necessary control of the renovation process. Furthermore, the arbitration tribunal stated that the so-called building unit penalty for apartments in the same building unit had not been set as an ordinary interim key date, seeing that this daily penalty was linked to the completion of all works in the apartments in the same building unit. As a result, the employer was not deprived of the right to charge the building unit penalties as the renovation works were completed on time.

In summary, it can be concluded that the arbitration tribunal in the rulings referred to above acknowledged the employers' right to charge daily penalties for partial deadlines that have been exceeded irrespective of the four cumulative conditions for charging daily penalties with regard to interim key dates, and irrespective of whether the entire contract was completed on time3. However, the rulings have probably not changed arbitration case law regarding daily penalties for exceeding interim key dates, but they contribute to defining the scope of application for this area of arbitration case law and the definition of an interim key date.