Supreme Court provides much-needed clarity on liquidated damages

In handing down its judgment in Triple Point Technology v PTT last week, the Supreme Court has provided the construction industry with much needed certainty and clarity on how liquidated damages (LD) clauses will be interpreted by the courts. Despite the facts of the case having nothing to do with construction, the preceding Court of Appeal (CoA) decision had created no small amount of uncertainty across swathes of construction contracts, and the successful appeal of that decision has been welcomed across the industry.

In this Insight, we look at the facts behind the Triple Point litigation, and the judgments which created, then resolved, uncertainty as to the proper application of LD clauses where a contract is terminated before works are completed.

Facts of the case

The case involved the supply and installation by Triple Point of software systems to PTT. The works to be delivered under the contract were divided into 18 milestones, with the successful completion of each milestone by the pre-agreed dates generating an entitlement to payment of a proportion of the contract price. Failure to deliver the milestone by the agreed dates triggered the payment of LDs.

Triple Point was severely delayed in its execution of the works, completing the first and second milestones 149 days late. None of the subsequent milestones were completed. As such, PTT terminated the contract and the remaining works were never completed.

Triple Point brought a claim against the PTT for non-payment under the contract, and PTT brought a counterclaim for compensation for failure to perform the contract, including LDs for delay pursuant to the following clause of the contract:

"If CONTRACTOR fails to deliver work within the time specified and the delay has not been introduced by PTT, CONTRACTOR 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 PTT accepts such work…" (emphasis added)

The key question before the court in terms of LDs was as follows: did the LD clause apply where the works had indeed been delayed, but the contract had been terminated before the works were ever completed?

Journey through the courts

At first instance, the TCC decided that the LD clause applied to all aspects of the delayed works, and PTT was entitled to LDs. The case then went to the CoA, who stressed that the correct interpretation of LD clauses would always depend on the precise wording of the LD clause. The CoA went on to highlight three possible interpretations of this LD clause in circumstances where the contract had been terminated prior to completion of the works, all of which it said could be supported by different strands of case law:

1. The clause does not apply at all (as the LD clause requires PTT to accept the works, which never occurred).

2. The "orthodox" view that the clause applies for any period of delay up to termination of the original contract.

3. The clause applies even after termination of the contract, and until the point that a second replacement contractor achieves completion (at which point the works are accepted by PTT).

In interpreting the LD clause in this case, the CoA noted that though option 2 was generally treated as the orthodox analysis in legal textbooks, it was "not free from difficulty". The court went on adopt the first option, finding that in order for the LD clause to apply, PTT must have gone on to accept the delayed work. As the work relating to the majority of the milestones had never been accepted, PTT was only entitled to LDs for the delay to milestones 1 and 2 (which had actually been completed). For the remainder of the incomplete works, PTT was instead entitled to general damages, assessed on the ordinary principles.

The Supreme Court judgment

Though the Supreme Court agreed with the overarching statement from the CoA that the application of an LD clause will always turn on the specific drafting of the clause itself, the court disagreed on the interpretation of the clause in this case, and held that LDs for delay to the works applied up until the time that the contract was terminated (as per the second, "orthodox" option listed by the CoA).

In giving the lead judgment, Lady Arden noted that the CoA's interpretation was "inconsistent with commercial reality and the accepted function of liquidated damages". Lady Arden reasoned that contractual counterparties agree LDs clauses to provide a remedy that is predictable and certain for a particular event (here, delay to completion of the works), and that it is well understood by contracting counterparties that the accrual of LDs comes to an end on termination of the contract, after which point any further remedies must be sought under general law. There is no need to provide specifically for the effect of the termination of their contract. The court found that this interpretation was better aligned with the wording of the clause, which had intended to make the acceptance of the work by PTT an end date for the accrual of LDs, not a pre-condition to the right to claim LDs.

Lady Arden also noted that this interpretation had the benefit of ensuring that any rights of the parties that had accrued prior to termination were not lost on termination. Though the importance of protecting such rights had been emphasised in the CoA judgment, the Supreme Court pointed out that the consequences of the CoA's interpretation meant that accrued rights would be lost rather than protected. Notably, in his supporting judgment, Lord Leggatt also highlighted the perverse conclusion under the CoA's interpretation that a contractor who was in severe delay would be incentivised to not complete the work – as only at the point of completion would liability to pay LDs be triggered.

What does this all mean?

The Supreme Court's judgment has, unsurprisingly, been roundly welcomed by construction industry practitioners.
The CoA's judgment had left those administering contracts containing LD clauses that didn't cater for termination uncertain of the implications of terminating a contract prior to completion of the works on the ability to claim LDs. Questions had also arisen under these contracts as to whether the CoA decision meant that works had to be completed prior to any LDs becoming payable, throwing into doubt the well-established industry practice of an employer claiming LDs during the period between the target date for completion of the works, and the actual date for completion. The return to normality signalled by the Supreme Court puts many of these issues to rest.

Contract drafters will also no longer feel obliged to insert express provision for the termination of a contract prior to the completion of the works in LD clauses as a result of this judgment – a practice that had become widespread as a result of the CoA decision. This practice notably extended to the NEC, who last year issued an update to the NEC4 suite of contracts to cater for the CoA's decision. The overarching message that the wording of the LD clause in each case will determine how it applies in any given circumstance should of course always be borne in mind, and care should be taken to ensure that contracts containing LD clauses operate in the way intended by the parties.