Provisions for the payment of liquidated damages (“LD Provisions”) are often included in construction contracts. The critical question to any party new to contracting in Qatar is 'whether or not the term negotiated into the contract will be enforceable?'
Article 171(1) of Law no (22) of 2004 Regarding Promulgating the Civil Code 22 / 2004 (‘’the Civil Code’’) provides an overarching principal to the effect that a contract between the parties must be honoured by them. Article 171(1) provides that:
“a contract is the law of the contracting parties, and so cannot be revoked or modified except with the agreement of the parties or for such reasons as prescribed by law”
As highlighted here, Article 171(1) warns of exceptions to this overarching principal. This article will highlight the relevant provisions of the Civil Code which can impact on the enforceability of an LD Provision and therefore need to be considered by the parties when negotiating, drafting and administering the contract.
The Civil Code expressly recognises LD Provisions at Article 265 (which relates to compensation), where it states as follows:
“Where the obligation is the payment of money, the contracting parties may calculate the amount of indemnity in advance in the contract or in any subsequent agreement.”
As such, Article 265 provides no restrictions on the parties’ rights to include a provision for the pre-determination and payment of damages. Despite this, the Civil Code does go on to impose some significant restrictions to this provision that must be taken into account when negotiating and drafting LD Provisions.
Exaggerated Liquidated Damages
Article 266 provides as follows:
“No agreed indemnity shall be payable if the obligor proves that the obligee has suffered no damages. The Court may decrease the agreed amount of indemnity if the obligor proves that the calculation is exaggerated or if the obligation has been performed in part. Any agreement to the contrary shall be invalid.”
Firstly, Article 266 provides that liquidated damages will not be payable where the employer has not suffered any loss. This element to Article 266 is not overly troublesome, as it is hard to envisage circumstances where a delay is not causing some form of loss to the employer. Despite this, even if such circumstances were to arise, the position of prohibiting the employer from profiting from a delay (albeit an encroachment on the parties’ freedom of contract) appears not to be an unreasonable one.
However, Article 266 also provides that a Court may decrease the agreed amount of liquidated damages if the contractor can prove that the compensation payable pursuant to the LD Provisions was “exaggerated’ or if the obligation “has been performed in part”. It therefore provides the contractor with the right to seek relief where the rate or quantum of liquidated damages has been negotiated too high. This is a protective measure in favour of the contractor that is enshrined in the Civil Code and cannot be contracted out of.
It is therefore critical for the employer not to negotiate an excessive rate of liquidated damages. The consequence of which could result in the contractor challenging the terms of the LD Provision. The obvious pitfall of such actions is the loss of the primary benefit of the LD Provision. As a consequence, the employer will incur the cost, uncertainty and delay arising when a third party is required to determine the quantum of damages.
Insufficient Liquidated Damages
In stark contrast to Article 266, Article 267 prohibits the employer from seeking the same relief from the Court in circumstances where the loss suffered by an employer is much more substantial than the damages recoverable pursuant to the LD Provision.
Article 267 of the Civil Code provides a very limited scope where the Court can intervene to award a higher amount and states as follows:
“Where the damages exceed the agreed amount of indemnity, the obligee may not claim a higher amount unless he proves the obligor's fraud or gross negligence.”
As such, an employer will generally be bound by the pre-determined rate and cap (if any) concerning liquidated damages.
This reiterates the importance of the employer getting the calculation right when the parties agree to include an LD Provision in their contact. Where an employer has underestimated the potential loss caused by delay, or where circumstances have changed causing a much greater loss than was first expected, the Court can only consider intervening to award a higher amount in incidents of “fraud or gross negligence”.
This includes the total of any cap on liquidated damages that has been agreed by the parties. As a consequence, being too lenient (or too cautious in light of Article 266) could come at a significant cost to the employer. Consequently, there is a need to balance the effect of Article 266 against Article 267 respectively.
Liquidated Damages and Good Faith
Article 172(1) of the Civil Code provides that “a contract shall be performed in accordance with its provisions and in such manner consistent with the requirements of good faith.”
Article 172(2) further provides that a “contract shall not be limited only to binding a party to its provisions but shall also cover whatever is required by law, customary practice and justice in accordance with the nature of the obligations contained in the contract.”
The above overarching requirements introduce a substantial amount of uncertainty to any contract. However, when considering their application to LD Provisions, the employer can be confident that Article 172 will not invalidate their LD Provision if:
- The conditions of the LD Provision are in a standard form and have been fairly negotiated;
- The rate of liquidated damages is based on a genuine pre-estimate of loss, and this calculation can be evidenced in the future if it is called into question; and
- The clause is administered fairly by the employer in the event that the default occurs.
Consistent with the requirement to administer an LD Provision fairly and in good faith, Article 257 provides as follows:
“The Court may decrease the amount of indemnity or reject any request for indemnity where the negligence of the obligee contributed to or aggravated the damage.”
This clause is consistent with the common law ‘prevention principal’ and the intent of sub-clause 8.4(c) of the FIDIC Silver Book 1999. As a consequence, an employer cannot not look to enforce the LD Provisions where it has been responsible for the delay.
Liquidated damages gives the parties certainty in the event of a specific default, giving the employer a right to an agreed level of compensation that can be applied without determination by a third party.
The decision to include LD Provisions in a contract needs to be carefully considered, taking into account the benefits of the clause with the limitations imposed by the Civil Code.
Although Article 171(1) of the Civil Code appears to give the parties freedom of contract, it’s essential that the relevant provisions of the Civil Code are taken into account to ensure the provision is enforceable and effective. Although ‘penalty clauses’ (as known in many common law jurisdictions) are not unenforceable in Qatar, applying the same the principals (as those used in such jurisdictions) to Qatari contracts is highly recommended. Furthermore, good faith, fairness and reasonableness are all important factors to keep in mind when negotiating, drafting and administering the LD Provisions.
If payment is the carrot enticing the contractor to perform its obligations, liquidated damages are often viewed as the stick, driving the contactor to complete the works on time. However, for the reasons set out in this article, such analogy or mind-set is somewhat misguided.