Liquidated Damages are defined as “a sum which a party to a contract agrees to pay or a deposit which he agrees to forfeit if he breaks some promise and which, having been arrived at by a good faith effort to estimate in advance the actual damage which would probably ensue the breach, are legally recoverable or retainable as agreed damages if the breach occurs.”
A Penalty
A penalty is defined as “a sum which a party similarly agrees to pay or forfeit in the event of a breach, but which is fixed not as a pre-estimate of the probable actual damages but as punishment, the threat of which is designed to prevent the breach.”
. Legal Stand
For courts and lawyers, the problem of having either of the following cases has not been dealt with consistently.
* An actual loss, as a result of late completion, being nil or less than the amount stipulated in the Liquidated Damages clause.
* An actual loss, as a result of late completion, being far greater than the amount stipulated in the Liquidated Damages clause.
In the United States, the courts tend not to enforce the Liquidated Damages clauses when the stipulated amount exceeds the actual loss, as it has seemed to them that in the case of breach of contract, Justice requires nothing more than compensation by the amount of the harm suffered…therefore, courts have created a limitation on freedom of contract. (CORBIN on Contracts Vol.5, PAR1057)
The courts in England and Australia are more inclined to honor freedom of contract and enforce the clauses of the agreement regardless of the actual loss after testing the foreseeability of the “genuine pre-estimate of loss.”
Suppose the Liquidated Damages clauses are held to be a penalty and, therefore, void. In that case, the general rule in England is that the clause may be completely disregarded, and the Employer may sue for actual damages, which may exceed the sum stated in the Liquidated Damages clause. Famous Delay Cases:
Below, some cases are briefed where the legal stand with respect to liquid damages is shown to have varied under different laws.
The Gallo Case (UK)
The principles underlying the award of liquidated damages as considered by the Court of Appeal in Galoo v. Bright Graham Murray[1995], where the issue in the Galoo case was whether a firm of accountants and auditors were liable for the trading losses incurred by a company which had continued to trade relying upon the negligent audit work done by the firm. No doubt, it could be proved that if the firm had done its job properly, the company would have stopped trading and, therefore, would have avoided the subsequent trading losses. The question was whether this was enough to establish the causal link between the breach of contract (i.e., the careless audit) and the loss complained of. The Court of Appeal held it wasn’t. ”
…if a breach of contract by a Defendant is to be held to entitle the Plaintiff to claim damages, it must first be held to have been an “effective” or “dominant” cause of his loss. It is necessary to distinguish between a breach of contract, which causes a loss to the Plaintiff, and one that merely gives him the opportunity to sustain the loss.
The case, though not directly a construction dispute case, raised the question of the legitimacy of a default by one party to a contract to the other party’s default.
The St. Jones College Case (Australia)
It is worth mentioning the St. Jones College case, where the Australian contractor could not be relieved from his initial agreement to complete the works on time on the grounds that the delay was not his fault.
The Utley James Case (US)
In the case of Utley James, the court in the United States did not assess the contractor responsible for the delay, which did not affect the critical path.