Despite parties’ best intentions, we often find that the timelines parties commit to in negotiations are perhaps, in hindsight, overly optimistic or may not always accurately reflect (or anticipate) the realities of service delivery. The early stages of implementation can often be marked by delays, some of which may jeopardise project timescales, budgets and, in worst-case scenarios, viability.
To counteract this, contracts often provide that liquidated damages or other forms of “delay payment” will be payable in the event of delays. However, without a well-structured delay clause, customers can find themselves with a frustrating inability to incentivise suppliers to deliver on time, or to cover delay-related costs without having to resort to a formal claim. Equally, suppliers can find themselves faced with ill-founded attempts to claw back payments or bearing the contractual burden of a delay where its cause(s) may lie at least in part with the customer.
Two cases together have helped set the current framework for drafting an effective provision for liquidated damages: Cavendish Square Holding BV v El Makdessi  UKSC 67 and Triple Point Technology Inc v PTT Public Company Ltd  EWCA Civ 230.
Makdessi is a now familiar case that has helped to reshape the way we think about contractual penalties. Makdessi was a conjoined appeal of two different cases regarding penalty clauses: one regarding a share sale agreement that had a reduction in price for default of clauses restricting competition by the seller, and the other regarding a parking charge for overstaying a free parking period.
Before the decision, penalty clauses would only be enforceable if they represented a genuine pre-estimate of loss (and you will find many contract terms that include these words when providing for delay payments). After the Supreme Court judgment, the test is now whether the clause in question is a secondary obligation that imposes a detriment which is out of all proportion to the legitimate interest of the innocent party. Such clauses are penal and will be unenforceable.
Makdessi made clear that it is possible to have a legitimate interest in enforcing performance which does not equate to mere compensation for your losses. In this regard, the court acknowledged that in a “negotiated contract between properly advised parties of comparable bargaining power, the strong initial presumption must be that the parties themselves are the best judges of what is legitimate in a provision dealing with the consequences of breach”. In otherwise words, the parties themselves are usually best-placed to make the analysis as to the cost implications of a breach of a primary obligation. As such, deterrent clauses that include financial disincentives for breach may well be allowed after Makdessi, provided that the sums payable in relation to a breach are not unconscionably high or exorbitant by reference to the relevant legitimate interest in performance of the contract.
In the context of delay payments, this enables parties to look beyond the language of “genuine pre-estimate of loss” and, depending on the comparability of bargaining power, consider other ways of constructing delay regimes and associated payments.
Triple Point concerned a software supply agreement, under which Triple Point was to provide software to PTT in two phases. There was a deadline on completion of Phase 1, with failure to meet such a deadline resulting in Triple Point being liable to pay damages “at the rate of 0.1% … of undelivered work per day of delay from the due date for delivery up to the date PTT accepts such work”.
When Phase 1 was delayed and key milestones for payment not met, Triple Point suspended work until it received further payment and PTT terminated the contract in response. Triple Point claimed against PTT for sums it considered to be outstanding, and PTT counter-claimed for delay.
At first instance, the judge held that Triple Point had committed a repudiatory breach of the agreement through its suspension, and so PTT could terminate and claim damages. As well as recovering the costs of procuring the software from a third party and wasted costs, the judge at first instance also allowed PTT to recover liquidated damages for delay, which were outside the contractual liability cap.
Whilst the Court of Appeal largely upheld the first instance judgment, it did not agree on the recoverability of liquidated damages. It held that, here, liquidated damages for delay were not recoverable where the contractor did not complete the contracted work on the drafting of the contract. Crucially however, it allowed that the recoverability of liquidated damages up to termination or abandonment, or potentially even beyond, depended on the wording of the clause itself.
Drafting a strong delay regime
The cases above show that it is possible to have enforceable, well-drafted liquidated damages provisions to allow for delay-related payments. However, it is easy to inadvertently undermine them by not considering all possible outcomes. The following key points from Makdessi and Triple Point may help avoid unintended consequences when putting together your own clauses:
- Delay payments should relate to primary obligations only. Resist the temptation to apply liquidated damages to obligations which are not of fundamental importance in the context of performance of the contract.
- When setting the value of delay payments, you may go beyond a genuine pre-estimate of loss and include deterrent value. However, this should be proportionate to your interest in the performance of the obligations in question. A clause is more likely to be penal if it applies equally to a range of obligations which vary in criticality to service delivery. It may also be helpful to document the parties’ rationale behind the value of a given payment.
- Make clear if you intend for liquidated damages to be recoverable where work is not completed (as opposed to being delayed but ultimately completed). This is particularly important if work is split across milestones and phases. You should consider what the cost consequences will be if no work is ever undertaken on a given phase or milestone and how that interacts with any “delay” payments.
- Be clear about the relationship between your liquidated damages regime and termination. If termination is not intended to prevent the accrual of liquidated damages, make that an express provision in your agreement.
- Will liquidated damages or other forms of delay payment fall within, or sit outside, limitations of liability? Should a customer be able to recover delay payments from a supplier without diminishing the supplier’s liability cap? Liability drafting should clarify these questions.
- Where delay is the result of mixed causes (e.g. both supplier and customer contribute to delay), ensure that the contract has a workable regime for apportioning fault (if necessary) and that any triggers exercisable by supplier or customer appropriately reflect the circumstances (and cause) of delay.
Please see here for further information on liquidated damages and Triple Point Technology Inc v PTT Public Company Ltd  EWCA Civ 230.