Enforceability of Liquidated Damages Provisions

Following Stuart Thompson’s recent blog about GPP Big Field LLP v Solar EPC Solutions SL (“GPP”) and in particular whether liquidated damages continue to accrue following termination up to completion (in short, they do though the decision is surprising and likely to be challenged), it is worth looking at the decision made on whether or not the liquidated damages provisions were enforceable.

The Supreme Court’s recent decision in Cavendish Square Holding BV v El Makdessi and ParkingEye Ltd v Beavis and decisions given in ZCCM Investments Holdings plc v Konkola Copper Mines plc were considered and referred to. To summarise the judgment in GPP:

1.        the question of whether a damages clause is a penalty falls to be decided as a matter of construction as at the time that it is agreed;

2.        the key considerations as to whether damages amount to a penalty can be described as follows:

“The true test is whether the impugned provision is a secondary obligation which imposes a detriment on the contract-breaker out of all proportion to any legitimate interest of the innocent party in the enforcement of the primary obligation…”;

“What is necessary in each case is to consider, first, whether any (and if so what) legitimate business interest is served and protected by the clause, and, second, whether, assuming such an interest to exist, the provision made for the interest is nevertheless in the circumstances extravagant, exorbitant or unconscionable ...”

“… the correct test for a penalty is whether the sum or remedy stipulated as a consequence of a breach of contract is exorbitant or unconscionable when regard is had to the innocent party's interest in the performance of the contract...”.

In GPP, the obligation to pay the liquidated damages was a secondary obligation to the primary obligation to carry out the works in line with the contractual timetable. A key point raised by the defendant was that the levels of liquidated damages were the same across the several EPC contracts, despite the specifics and financial details involved in those contracts being different.

The defendant attempted to challenge the level of liquidated damages as not being “based on a genuine pre-estimate of the losses likely to be suffered” and being “lifted without discussion” from the contract on which the EPC contracts were based. When these points were considered, it was decided that the liquidated damages level specified:

• was agreed between “experienced and sophisticated commercial parties of equal bargaining power”;
• did not exceed a genuine attempt to estimate in advance the loss which would be likely to suffer from a breach;
• was not in any way extravagant or unconscionable in comparison with the legitimate interest of the first claimant in ensuring timely performance; and
• was not an exorbitant or unconscionable estimate of the likely loss caused by any delay.

The liquidated damages provisions were therefore enforceable.

The decision in GPP is helpful as it provides further guidance on how such provisions will be analysed, and how any challenge to their enforceability may be assessed.