Liquidated damages clauses are commonplace in the construction industry and are often linked to breaches of time obligations and performance specifications. Such clauses can be struck down if they are held to constitute a “penalty” aimed at deterring a breach of contract rather than providing compensation for loss. A recent case in the Technology and Construction Court has considered the validity of a liquidated damages clause linked to unauthorised changes in personnel under a construction contract.

Background

The case concerned a sub-contract between Bluewater Energy Services and Mercon Steel Structures as part of a wide ranging dispute.  The sub-contract related to works at the Yuri Korchagin Oil Field in Russia for the construction of a soft yoke mooring system.

The sub-contract contained a list of Mercon’s key personnel and provided that, firstly, Mercon could not change key personnel without Bluewater’s prior approval and, secondly, Mercon would pay liquidated damages to Bluewater for each replacement, unless otherwise agreed.  The liquidated damages applied to 7 key personnel and ranged from €20,000 to €50,000.

A number of replacements occurred and Bluewater claimed liquidated damages.  Mercon, however, argued the liquidated damages were a penalty and the clause was unenforceable.

A penalty?

A liquidated damages clause will not be enforceable if the real intention of the clause is to deter a party from breaching the contract.  One factor to be considered in ascertaining the intention of the clause is the amount of the liquidated damages compared to the actual loss that might be sustained by the innocent party.

Mercon referred to the 2009 case of Fitzroy Robinson v Mentmore Towers Limited, where an employer brought a claim for fraudulent misrepresentation against its architect.  The architect represented that a key staff member would be available for a contract, whereas they had already handed in their notice.  The architect was found liable for fraudulent misrepresentation, but the court held the employer had not suffered any loss as a result of the change in personnel.  Any element of duplication or disruption was shouldered by the architect and was not passed on to the employer.  

Mercon therefore argued that any actual loss suffered by Bluewater would be minimal and, in comparison, €50,000 was clearly intended to be a penalty to deter breach.  However, the court disagreed.  It emphasised the court’s general reluctance to interfere with an agreed contractual term and noted that the parties had freely negotiated the liquidated damages amount. Although it was impossible to put a precise figure on any loss suffered by Bluewater, the figure had been assessed by people who were experienced in such projects.  In the context of the project, €50,000 was not unconscionably extravagant. The court also noted that the difficulty of putting a precise figure on any loss suffered was a pointer in favour of the clause being a genuine pre-estimate rather than a penalty.

Conclusion

This case provides useful clarification for those agreeing liquidated damages clauses.  The impossibility of determining precisely what loss is suffered will not prevent liquidated damages from succeeding.  In fact, these are precisely the situations in which liquidated damages are most useful.  Much depends on the facts, but where there is evidence of free negotiations (which is admissible when considering a liquidated damages clause) together with an assessment of potential losses and an attempt by the parties to value those losses, the courts will be reluctant to interfere.

References:

Fitzroy Robinson v Mentmore Towers Limited [2009] EWHC 1552 (TCC)

Fitzroy Robinson v Mentmore Towers Limited [2009] EWHC 3365 (TCC)

Bluewater Energy Services BV v (1) Mercon Steel Structures BV (2) Mercon Holding BV (3) Mercon Groep BV) [2014] EWHC 2132 (TCC)