As the race for silverware in the football season hots up, I am sure that players, commentators and fans will all be analysing refereeing decisions from their own particular perspective. One area that has triggered a lot of analysis and discussion is the Video Assistant Referee, particularly when looking at penalty decisions. I am often asked by developers, contractors, subcontractors and surveyors prior to starting a project when contracts are being negotiated or after works have started when delays occur to apply my video review to comment on whether the liquidated damages figures in the contract are suitable, appropriate and enforceable. My advice, based on the current law explained further below, is that parties can now apply more commercial pressure and consider the wider context of the project as a whole when deciding upon or challenging the contractual liquidated damages figure for culpable delay.
The previous test coming from Dunlop Pneumatic Tyre v New Garage & Motor Co (1915) of whether the liquidated damages figure is a genuine pre-estimate of loss, has now been superseded by the Supreme Court’s decision in 2015 to re-set the doctrine in this area. The concept of prior calculations of a pre-estimate of loss was well understood and in most cases subject to mathematical calculations based on the purpose and end use of the works. However, in the Cavendish Square v El Makdessi and Parkingeye v Beavis (2015) appeals, the Supreme Court restated the test for a decision as to whether the liquidated damages number was enforceable or in fact a penalty. The Supreme Court said:
“the true test is whether the provision is a secondary obligation which imposes a detriment on the party who broke the contract which is out of all proportion to any legitimate interest of the innocent party in the enforcement of the primary obligation”.
In practical terms, the Supreme Court have made it more difficult to argue that a liquidated damages clause is a penalty and the commercial interests of the various parties are now the focus of any analysis in this area.
Going back to the subject of football, the Court of Appeal in Houssein v London Credit (2024) has seen the ongoing problems and applied their version of VAR to set out clearly the tests and review process that parties must consider to apply the Supreme Court’s decision in each case.
These various cases do not directly arise out of a construction project, but actually relate to banking, car park tickets and other issues, but the principle is of wide application across the board and directly affects people using building contracts.
In the Houssein case in the Court of Appeal, the challenge to the clause related to a rate of 3% per month above the standard interest rate accruing daily on a compound basis. The Court of Appeal decided that the Judge had applied the wrong test in deciding that the clause was a penalty and took the opportunity to set out the process for applying the Supreme Court’s statement of the law in this area.
Firstly, the parties should assess whether the clause is imposing a secondary obligation on the party required to make payment. If the obligation to pay is a primary obligation, such ordinary contractual arrangements where one person carries out an act and the other pays, then this penalty analysis does not apply. It remains necessary to establish that the obligation to pay arises on a breach of contract because the existence of the breach (failing to complete on time) establishes the secondary obligation to trigger the liquidated damages for culpable delay.
Secondly, the Court of Appeal highlighted that the parties should focus on the extent and nature of the legitimate interest which is being protected by the liquidated damages clause. The legitimate interest is the interest of the party seeking payment. In some cases, this could mean financial interests, but this is not always a simple financial analysis. As long as the legitimate interest is a genuine business proposition, then those facts and contexts can be taken into account. The Court of Appeal feels that people should look at the commercial justification for charging the particular liquidated damages for delay on an objective basis. Parties should look at the purpose of the clause and the relevant commercial background.
Thirdly, the parties must consider whether the sum is extortionate, exorbitant or unconscionable. It is tempting to try to justify the particular figure, rather than objectively considering whether the rate is extortionate. It is not up to the party to provide a justification for using that figure. The Court of Appeal confirmed that the party seeking to challenge the clause has to show that the sum is extortionate. This is not an easy test to satisfy if two commercial parties are of relatively equal bargaining power or have had professional assistance when drafting and negotiating the contract.
As a result, the Dunlop test of the genuine pre-estimate of loss now stands as a purely evidential test which may be put forward by the party seeking to challenge the liquidated damages to show that they are extortionate or unconscionable but does not itself stand as the single test of whether the clause is a penalty. The analysis on every case will be tricky, much the same as the VAR process in a football match where the referee goes to the side of the pitch to study the slow motion replays. The Court of Appeal has taken the rule book from the Supreme Court and looked at the video replays seeking to remind players, commentators and fans what is required to win or overturn a penalty.
The information provided in this article is provided for general information purposes only, and does not provide definitive advice. It does not amount to legal or other professional advice and so you should not rely on any information contained here as if it were such advice.
Wright Hassall does not accept any responsibility for any loss which may arise from reliance on any information published here. Definitive advice can only be given with full knowledge of all relevant facts. If you need such advice please contact a member of our professional staff.
The information published across our Knowledge Base is correct at the time of going to press.
