Liquidated damages clauses exist to create certainty around how much can be claimed when a contract is breached. Put another way, they are introduced to deal with the difficulty of predicting the amount potentially recoverable as damages for breach of a contract. A recent ruling by the Supreme Court in Triple Point Technology Inc v PTT Public Company [2021] UKSC 29, explored liquidated damages clauses effectiveness in the context of the failed delivery of a software system. The case also explored the effectiveness of exclusion clauses and the definition of negligence.

Liquidated damages clauses

Liquidated damages clauses frequently appear in commercial contracts and, most commonly, in relation to late or defective performance, particularly in the fields of construction, engineering, supply of goods and shipping contracts. Advantages of liquidated damages clauses include:

  • The parties can know in advance what their liability is and how much they could receive in a breach specified by liquidated damages clauses.
  • They could make recovery of damages easier. This is due to the fact that liquidated damages clauses are enforceable regardless of needing to quantify the loss actually suffered by the innocent party, as would be the case when considering the amount payable to the innocent party when unliquidated damages apply (read our blog on the topic: Damages for Breach of Contract). The claimant simply must show that a breach of contract falls within the scope of the liquidated damages clause. It therefore follows that a claimant may be able to recover more than would be recoverable if the damages were unliquidated (as affirmed in Philips Hong Kong v AG of Hong Kong [1993] 61 BLR 41).
  • Vice-versa, liquidated damages clauses can work in favour of the party responsible for the breach where the damages caused would be more if unliquidated. When considering the drafting of such a clause, it is important to have these considerations in mind, including who is likely to be in breach and what sort of magnitude is imaginable, whilst also being aware that if liquidated damages clauses do not represent a genuine pre-estimate of potential damages, they could be deemed invalid.
  • They help with dealing with minor breaches in long-term contracts (such as construction) and so help to maintain a commercial relationship when there have been minor breaches throughout. In this vain, liquidated damages can be applied to specific obligations in a long-term commercial agreement and so compartmentalise potential breaches.

Can you still claim for general damages when liquidated damages clauses are included in the contract?

Usually, liquidated damages clauses relate to specific breaches and so only apply to the scope of the breaches referred to in the clauses themselves. Therefore, general damages will be claimable for breaches beyond the scope of liquidated damages clauses, subject to any other provisions in the contract. There have, however, been some unusual exceptions to this rule. Including:

So long as liquidated damages clauses clearly state the sort of breach they apply to and how they will operate, the exceptions referred to above should not apply. In Triple Point v PTT the case hinged upon some ambiguous wording in a liquidated damages clause, further proof that such clauses need to be considered at length. We now explore this recent case in depth.

Liquidated damages clauses: Triple Point v PTT

Triple Point Technology Inc (Supplier) contracted to design, install and maintain a software system for PTT Public Company (customer). Payment was due in instalments on completion of milestones. The supplier’s performance did not meet the contractual timetable. Some of the delayed work was accepted and paid for but the customer refused to make other payments for work not yet completed. The supplier suspended work and the customer terminated the contract.

Liquidated damages clauses point in Triple Point v PTT

The supplier brought an action for payment of its unpaid invoices. The customer counterclaimed for damages and liquidated damages under the contract, as provided under article 5.3:

“If the supplier fails to deliver work within the time specified and the delay has not been introduced by the customer, the supplier shall be liable to pay the penalty at the rate of 0.1% (zero point one percent) of undelivered work per day of delay from the due date for delivery up to the date the customer accepts such work, provided, however, that if undelivered work has to be used in combination with or as an essential component for the work already accepted by PTT, the penalty shall be calculated in full on the cost of the combination.”

As shown in bold above, the point here was whether PTT had to accept the work for the liquidated damages to be payable. Put another way, article 5.3 could be interpreted to mean that damages for delay would only be payable under this clause if the work was eventually completed and accepted by PTT, which was not the case. Whilst the Court of Appeal held that the clause did not apply because the work was never completed, the Supreme Court criticised this and ultimately overruled it, deeming it inconsistent with commercial reality and the accepted purpose of liquidated damages clauses. The Supreme Court said that parties must be taken to know the general law, that is, that the accrual of liquidated damages comes to an end on termination of the contract, and so given the work had not been completed up to this point, the clause would apply. After that point in time, the parties must seek damages for breach of contract under general law.

The limitation clause point in Triple Point v PTT

Article 12 of the contract placed a cap on the amount of damages that could be recovered and included an exception from that cap for “negligence”:

“… The total liability of the supplier to the customer under the contract shall be limited to the contract price received by the supplier with respect to the services or deliverables involved under this contract. … This limitation of liability shall not apply to the supplier’s liability resulting from fraud, negligence, gross negligence or wilful misconduct of the supplier or any of its officers, employees or agents.”

The Court of Appeal held that the word ‘negligence’ must mean some independent tort and did not mean breach of a contractual duty of skill and care. In other words, the Court of Appeal concluded that the cap applied to negligently performed contractual duties and therefore Triple Point’s liability for its negligent approach to contractual duties would be limited by the cap. The Supreme Court disagreed, holding that negligence should be given its natural and ordinary meaning of removing from the cap all damages for negligence on the supplier’s part, including damages for negligent breach of contract. Therefore Triple Point’s negligent approach to contractual duties was not capped and their total liability (including under the liquidated damages clause) amounted to just over $14.5 million.

Draft carefully

The context in which liquidated damages clauses classically apply is in a construction context. This is because construction projects span many years, many stages of development and, usually, many parties. Consequently, to thread these various elements together without allowing small-scale breaches to break down a project, liquidated damages clauses are a useful way to define exactly what remedy is available for failed or delayed sections of work. As shown by Triple Point v PTT, these clauses are also significant in any long-term delivery supply contract and employment contracts also often make use of them. This ruling will be received with relief by many, especially considering many were concerned by the lack of commercial consideration in the Court of Appeal’s decision.

What becomes clear from looking at case law in this area is that the wording of liquidated damages clauses can have a significant impact on how they will be interpreted if a contractual relationship goes to litigation. Given the often-bespoke nature of these clauses because they concern the specific work to be done and any imaginable remedies, there is a risk that the wording can be loose and therefore seeking legal advice is very important. These clauses need to be meticulously thought through.

If you have any questions about liquidated damages clauses or about contract law more generally please contact Neil Williamson.