By Alexa Hall and Laura Warren/Doha


“Liquidated damages”, “liquidated and ascertained damages” (“LADs”) , “delay damages”; however described, the theory is simple. The parties to a construction contract pre-determine the level of damages that a contractor must pay to the employer in the event of certain specified breaches of contract.
The most common of these breaches is late completion; in short, the sum payable in the event of delay is fixed. Whilst LADs are not exclusive to delay-related damages, it is in this context that the legal and contractual factors connected to the levying of LADs are discussed.

Why use the LADs mechanism?

It is not unusual for a construction project to encounter delays. Delay costs money. Legal proceedings to determine general damages as a remedy for delay can be complex, time consuming and disproportionately costly. Therefore, the key perceived virtue of LADs is certainty.
From the contractor’s perspective, the LADs provision is designed to eliminate uncertainty over its potential liability in the event of delay, enabling it to better assess and price the risk of delay accordingly.
For the employer, it will no longer be charged with the cumbersome burden of proving its actual loss consequent upon delay but is able to either bring an action for the prescribed sum, or deduct the LADs from interim or final payments due to the contractor.
The intention is that LADs act as a deterrent to non-performance or, to put it more positively, an incentive for the contractor to complete its works before or on the due date, whilst simultaneously dispensing with the need for expensive and protracted legal proceedings to establish the extent of the loss flowing from the breach.
A “win win” theory you might say. The reality is quite different and as this article attempts to demonstrate, in practice, the operation of the LADs mechanism is rarely straightforward.

A genuine pre-estimate of loss

The pre-determined sum is essentially intended to be a genuine pre-estimate of the loss that the employer will suffer if the contractor does not meet the contractual completion date. The LADs may be expressed as a fixed hourly, daily or weekly sum or may be calculated by reference to a formula.
The trigger for payment of LADs is the failure by the contractor to complete on time. LADs are levied from the contractual date for completion (taking into account the correct operation of any extension of time provisions) up until the actual date of completion. It follows that the meaning ascribed by the parties to the word “completion” is important.
The rate of LADs would commonly be calculated on the basis of the cost to the employer of not having use of the works.
Therefore, the parties would not ordinarily fix an amount based upon the contractor having achieved legal completion. Instead, the concept of “practical completion” or “substantial completion” becomes relevant – the point at which the work is for all practical purposes sufficiently complete to be put into use.
Once the works are substantially complete and the site handed over to the employer, the employer’s loss will no longer relate to it having been deprived of use of the works.
To summarise, LADs are designed to accurately and fairly reflect the measure of compensation that would be required to put the employer in the position it would have been in had the delay not occurred.
This begs the question as to what happens when the parties agree (most likely in circumstances where the employer has the upper hand in terms of bargaining power) an arbitrary or excessive figure for the LADs?
For contracts governed by English law the answer is straightforward: it is a long established principle of English law that English courts will not uphold a clause that seeks to deduct monies from the contractor for delay to completion by way of a penalty.
In such cases, the contractor may argue that the LADs are not a genuine pre-estimate of loss and that the LADs provision should be struck out of the contract as an unenforceable penalty.
But what about Qatar law? The literal Arabic translation of “liquidated damages” is the word “fines”. Clearly there is scope for confusion in the use of potentially interchangeable terms such as LADs, fines and penalties. To address the position, one must turn to the provisions of local law which govern the interpretation and enforceability of the contractual provisions, and in particular, Law No (22) of 2004 (the “Civil Code”).
The principle enunciated in Articles 171 and 172 of the Civil Code is known as the “General Principle” and is akin to the common law freedom of contract principle. Article 171(1) states:
“A contract is the law of the contracting parties and so cannot be revoked or modified except with the agreement of the parties or for such reasons as prescribed by law.”
Essentially, therefore, the parties are able to agree the provisions of any contract which govern the relationship between them.
Article 172(1) reiterates this principle by stating that:
“A contract must be executed in accordance with the contents thereof and in a way that is consistent with the requirements of good faith”.
Parties are, therefore, bound by the contractual terms they have signed, including those provisions relating to the levying of LADs.
Article 265 of the Civil Code states that:
“If the object of an obligation is not a sum of money, the contracting parties may determine in advance the value of the compensation in the contract or in a subsequent agreement.”
In accordance with the General Principle and Article 265 of the Civil Code, parties are permitted under local law, to agree to a level of liquidated damages.
There is no distinction in Qatar law between penalties and liquidated damages, so parties are able to agree that penalties will be levied as damages for delay to completion.
The preconception based on the English law of penalties should be forgotten. Further, Qatar law appears to be in line with the change in terminology from the “old” 1987 FIDIC Red Book and the “new” 1999 version.
Interestingly, Clause 8.7 of the new Red Book no longer refers to “liquidated damages” but has replaced this term with that of “delay damages” and additionally, the drafting removes the clarification or reference as to whether the provision is intended to be a penalty – it is essentially superfluous drafting.
One might conclude, therefore, that under Qatar law, the intention behind LADs, namely a fair and accurate assessment of an employer’s potential loss, is lost. This is not so. Readers may be interested to hear that the terms of contract can be scrutinised, and perhaps, altered under local law for reasons presented by law.
Intervention in accordance with local law can occur in interpreting a contract when the provisions of a contract are unclear or it is claimed by one or both of the contracting parties that the contractual provisions do not reflect the intention of the parties. Importantly, the law permits the examination of the level of a pre-agreed, fixed compensatory sum and the increase or decrease of the amount to reflect the actual loss suffered.
I shall return to the Civil Code shortly in order to expand but suffice to say that the concept of a “genuine pre-estimate” is still as important a concept under Qatar law as it is under other common law jurisdictions.

An exhaustive remedy?

The extent to which a LADs provision will operate as an exhaustive remedy will depend upon the drafting and interpretation of the particular clause in question.
Typically, the LADs clause will cover a specific breach (for the purposes of this article, delayed completion) and will therefore represent an exhaustive remedy for that breach, thereby preventing the employer from recovering additional general damages.
The agreed amount therefore places a cap on the employer’s entitlement and equally, a limit on the contractor’s liability, again, in the interests of certainty.
It is important to note that this cap will only apply in relation to the specific breach for which LADs have been agreed.
There are, however, certain provisions of Qatar law that may assist an employer, whose sole remedy is LADs, in the event of project delay and who is left out of pocket due to having made a commercial decision to reduce the rate of LADs at the stage of contract negotiation.
Firstly, pursuant to Article 266 of the Civil Code, an adjustment of LADs in the circumstances set out in law is permitted. This provision gives the court, and equally a tribunal applying local law, the ability to intervene, despite what is agreed, to adjust the level of liquidated damages to reflect a party’s actual loss .
In the context of an application under Article 266 by the employer, the law therefore permits an increase in the agreed LADs rate. These rights of intervention might be used, for example, in the extreme case where a valid LADs clause provides for a rate of LADs as “nil” thereby remedying the situation where an employer would otherwise be entitled to zero damages.
Secondly, it is likely that an employer may rely on a principle that, although expressly enunciated in Egyptian law , is likely to apply equally in the state of Qatar – that of “serious fault”.
Essentially, where an employer can prove that its contractor has committed a “serious fault”, any contractual limitations on the contractor’s liability to the employer for delay shall not apply.
The term “serious fault” is not a defined concept, with the severity of the breach being determined on a case by case basis taking into consideration factors including the seriousness of the breach, the degree of skill of the defendant and the extent of the harm caused.
Whilst strictly speaking there is no exact equivalent to Article 255 of the Egyptian Civil Code in Qatari law, it is arguable that Article 253(2) of the Civil Code has the same effect: “In all cases, the debtor is liable for fraud or serious fault he suffers.”

Challenging a claim for LADs

As previously mentioned, an employer’s entitlement to levy LADs is rarely straightforward. There are circumstances where a contractor will seek to challenge the employer’s right to deduct or recover LADs. This article identifies the main grounds upon which a contractor is able to do so within the confines of the law.
A contractor’s defence to a LADs claim will either be based on the terms of its construction contract or the provisions of the local law that govern that contract (and for the purposes of this article, we shall assume the governing law is that of the State of Qatar).
The availability of contractual defences will largely be dependent upon the drafting and construction of the relevant provisions of the contract but the following are some of the key defences of which a contractor (and equally an employer) should be aware:
1) The breach is not within the scope of the LADs provision – it is a different breach to that referred to in the contract;
2) There is no breach because the works were completed in accordance with the requirements of the contract and the contractor should therefore be entitled to completion;
3) The employer did not comply with a condition precedent to its right to deduct or claim LADs;
4) The machinery of the contract for ascertaining the rate of LADs has irretrievably fallen down; and/ or
5) The contractor is entitled to an extension of time within the terms of the contract.
The above are purely contractual remedies and therefore it is important for a contractor to examine, and take legal advice in relation to, the terms of the contract relating to LADs and extensions of time to see whether the defence(s) is in fact available.
Qatar law provides a further tier of defences that may assist a contractor in defending a claim for LADs.

Adjustment

The first is the partial or complete defence under Article 266 of the Civil Code (referred to above).
 
Article 266 of the Civil Code states that:
“The agreed compensation will not be payable if the debtor shows that the creditor has not incurred a loss.  The court may reduce the compensation from what is agreed if the debtor shows that the determination is grossly excessive or that the obligation has been partially fulfilled. Any agreement to the contrary will be void.”
Under this provision, a court or tribunal applying local law is empowered to retrospectively change the parties’ express agreement as to the level of LADs if it can be shown that the employer’s actual loss is substantially less than the pre-agreed rate. The rate may be reduced to a level that genuinely reflects the employer’s actual loss.
For instance, and as alluded to above, where the employer is able to fully use the works, it is likely that no loss is suffered. Alternatively, the employer’s loss might only be trivial and/ or the rate of LADs grossly exaggerated in relation to the transaction at hand. A key element is therefore the ascertainment of the actual loss suffered by the employer as a result of the delay. The burden of proof in doing so in accordance with local law will ordinarily fall upon the party seeking the adjustment in damages, in this case, the contractor.
This entitlement originates from the approach adopted by local law in relation to the award of damages generally. If a party is in breach of its obligation, and the other party suffers a loss as a result, the usual remedy will be the monetary award referred to as damages.
The law relating to LADs starts with the law relating to damages; if a party is not entitled to damages, it cannot be entitled to LADs. The approach taken is a compensatory one with the amount of compensation being assessed on the basis of harm suffered. The injured party is able to claim proven losses that are the natural result of the other party’s breach and the level of damages will be quantified to appropriately and adequately compensate the injured party for that loss.
Therefore, whilst local law supports and upholds provisions agreed between the parties, it also supports the ability to award damages which are considered to represent actual loss despite such agreement.

A superseding fault

The law also assists a contractor that is able to show that its fault has been superseded by that of the employer. The concept of one party’s fault superseding the other’s is found in Article 257 of the Civil Code which states:
“The court may reduce the amount of the compensation, or not award particular compensation, if the creditor by his fault has contributed to the occurrence of the detriment or has increased it.”
An employer’s fault might be said to have superseded that of the contractor’s in cases where the employer’s fault was deliberate or where it caused the contractor to complete late.
In such cases, the essential element of causation is considered to be missing between the contractor’s breach and the employer’s loss so that no damages are payable at all.

Complete avoidance

Finally, the law permits a contractor to avoid the payment of LADs in circumstances where it can prove delay was caused due to circumstances beyond its control.
Article 204 of the Civil Code provides:
“If a person proves that the detriment has arisen from an external cause in which he played no part, such a force majeure, or unexpected event, or fault on the part of the person harmed, or fault of a third party, he is not bound to pay compensation, unless there is a provision that rules otherwise.”
Similarly, Article 256 of the Civil Code states:
“If the debtor does not execute the obligation in kind, or delays in executing it, he is obliged to pay compensation for the detriment sustained by the creditor, unless he proves that failure to execute, or delay in execution, was for an external cause in which he played no part.”
Accordingly, provided that risk for these events is not contractually allocated and in the event of a successful demonstration that the delay event is solely due to matters beyond the contractor’s control, a contractor may rely on Articles 204 and 256 to establish that it has no liability to the employer, whether for liquidated damages or its actual loss.

Conclusion

It is clear that the issue of entitlement to, and recovery of, LADs throws up an array of difficulties.
If one reminds oneself of the key purpose and alleged advantage of LADs provisions, namely, certainty for both parties, it is difficult to see how such purpose is served or how such advantage actually bears fruition given the legal framework that governs the operation, and more importantly, the adjustment, of such provisions.
The contract provides with one hand what the law takes away with the other. And yet, equally, local law provides the legal wherewithal to aid the plight of a party suffering at the hands of a LADs provision that does not represent a genuine pre-estimate of loss; in all other instances, if the employer’s claim for LADs is sustained on its own merits, the use of the principles for determining loss is unnecessary. A difficult line to draw.
This begs the question: “is there a better alternative out there for allocating the risk of delay?”


*** All Qatari Laws (save for those issued by the Qatar Financial Centre (QFC) to regulate its own business) are issued in Arabic and there are no official translations, therefore for the purposes of drafting this article we have used our own translation and interpreted the same in the context of Qatari regulation and current market practice.

*** Should you have any questions in connection with this article or the legal issues it covers, please contact Alexa Hall of Clyde & Co LLP at [email protected] or Laura Warren of Clyde & Co LLP at [email protected].