Legally Bound

Jordan ... the subcontract liquidated damages may be a fraction of the actual losses.

Jordan ... the subcontract liquidated damages may be a fraction of the actual losses.

Liquidated damages under subcontracts

STUART JORDAN* focuses on delays by subcontractors and the approaches main contractors can take to deal with such issues.

October 2020

How should subcontracts deal with delay? This is a question that doesn’t come up too often, and yet whole books are written about delay in main contracts, where delay, time extensions and liquidated damages are mostly dealt with in one almost-universal way.

Subcontracts can deal with delay in a few different ways. The most obvious approaches are:

•  Require the subcontractor to cover all delay liquidated damages payable by the main contractor under the main contract and (often) to meet the main contractor’s other liabilities arising, to the extent that the subcontractor is responsible for incurring those damages and liabilities; or

•  Require the subcontractor to pay an agreed rate of subcontract liquidated damages, based only on the question of delay to the subcontract works.    

Uncertainties can arise from either approach. A common problem in the “full indemnity” option arises from the need to establish individual responsibility for the overall main works delay to completion. With several trades in play as well as external factors such as late or poor design information or poor sequencing, it can be difficult to allocate individual responsibility.

Another difficulty is in getting subcontractors effectively to indemnify the main contractor for the full liquidated damages (and often the full cost of delay and disruption as paid out to other trades)  when the subcontractor’s individual involvement in the project – and its commercial benefit from it – is usually only a small fraction of the main contractor’s interest.

So the second option looks attractive: treat the subcontract like the main contract – with a set programme, agreed grounds for an extension of time and an appropriate rate of liquidated damages. It might, however, mean that the main contractor can recover only a fraction of its own delay liabilities in the event that main works completion is delayed by that one subcontractor alone.

Equally, it might mean that the main contractor recovers subcontractor delay damages where there are no main contract liquidated damages to pay. That might be because the delay in subcontract works was not critical to main works completion, or because the main contractor made other arrangements to avoid the claim, or the main contractor was just lucky that no claim was brought. And that is the question for today. Is this outcome right?

This question was central to a recent dispute. Comfort Management Pte Ltd engaged OGSP Engineering Pte Ltd on a sub-subcontract to carry out air-conditioning installation on a project in Singapore. However, OGSP did not complete those works, having demobilised and walked off part way through. Comfort claimed, among other things, delay liquidated damages. However, Comfort faced no claim for delay damages from the main contractor and OGSP argued that this meant Comfort could not recover for losses it had not suffered.

OGSP relied in part on the fact that the sub-subcontract was expressed as being “back to back” with Comfort’s subcontract, to argue that the outcome should be the same as in the subcontract. The dispute came to the Singapore High Court which ruled in favour of Comfort, that the liquidated damages were enforceable. The “back to back” nature of the sub-subcontract did not alter the basic business objective of agreeing liquidated damages, which is to provide certainty of liability in the event of delayed completion. The liability to pay these damages is not dependent on other considerations, including Comfort’s outcome under its subcontract.

Would this apply elsewhere? The Singapore decision is in line with the English Law approach to enforceability: if liquidated damages are agreed to protect a party’s legitimate commercial interests, then they are enforceable regardless of actual losses incurred, or not, by that party.

The position in the Middle East is very different. Just as an example, the UAE has strong legal principles to promote the sharing of the benefit of an agreement and fairness of outcomes. The UAE Civil Code includes provisions allowing a judge to intervene to make compensation equal to the claiming party’s loss (Article 309), to adjust any pre-agreed limit (390) and against exercise of a right if the interests asserted are disproportionate to the harm suffered by the other party (106). Other parts of the code deal specifically with unjust enrichment.

On the face of it, any one of the above provisions could have found a defence to enforcement and trigger a retrospective comparison of the agreed sums against actual losses. Regardless of the outcome, the main benefit of these provisions (speed and certainty) is already lost.

Coupled with the fact, as noted above, that the subcontract liquidated damages may be a fraction of those actual losses, this might explain the enduring popularity of the “full indemnity” approach to subcontractor delay.

 

* Stuart Jordan is a partner in the Global Projects group of Baker Botts, a leading international law firm. Jordan’s practice focuses on the oil, gas, power, transport, petrochemical, nuclear and construction industries. He has extensive experience in the Middle East, Russia and the UK.




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