Part One - Recent changes to the law of penalties – and their impact on Liquidated and Ascertained Damages (LADs)

What is a LADs Clause?

In short, a LADs clause provides that the contractor will pay damages to the employer if there is delay for which the contractor is culpable.  The figure should be a genuine valuation of pre-determined loss, assessed at the time that the contract is entered into. 

Calculating the LADs figure

When it comes to calculating the sum of LADs for inclusion in construction contracts, employers and contractors often require guidance on how such a figure should be assessed.  In the past the relevant guidance was to stress that the LADs figure be based on whether there has been a “genuine pre-estimate of loss”.  If not, the risk is that the clause will be deemed a penalty and will be held unenforceable (following principles set out in the 1915 case of Dunlop Pneumatic Tyre Co Ltd v New Garage & Motor Co Ltd).  Accordingly, a comprehensive assessment of LADs and record of such valuation has been advisable.

Since 1915, Courts have attempted to move away from or to develop a revised version of the test in Dunlop so that a calculation is based on commercial justification.  In particular, it was felt that clarification of the distinction between a penalty and a genuine pre-estimate of loss was necessary.  Therefore the recent consolidated appeals in 2015 of Cavendish Square Holding BV v Talal El Makdessi and ParkingEye Limited v Beavis in which the Supreme Court considered this distinction head-on has been most welcome, providing long overdue clarification on the subject. 

Cavendish and ParkingEye and the penalty principle

Both Cavendish and ParkingEye, although not construction cases, provided an opportunity for the Supreme Court to consider the principles underlying the law relating to contractual penalty clauses. In its decision the Court described the penalty principle as an “ancient, haphazardly constructed edifice which has not weathered well” and stressed the importance of its assessment for commercial contract law.

The facts of each case were as follows:

Cavendish

Cavendish centred on two clauses in an agreement concerning Mr Makdassi (M) and Mr Ghoussoub. M and Mr Ghoussoub were the co-founders and owners of an advertising and marketing communications group based in the Middle East (the Company).  Cavendish entered into an agreement to purchase a 47.4% stake in the Company, subsequently increasing Cavendish's holding in the Company to 60%.  Under the agreement certain restrictive covenants were imposed on M to prevent him from undertaking competing activities.  In the event that the covenants were broken, two clauses would come into effect:

·Clause 5.1 – M would no longer be entitled to the remaining two payments he was due under the agreement

·Clause 5.6 – M could be required to sell his remaining holding in the Company to Cavendish for a sum that would not account for any accrued goodwill. 

M did not comply with the restrictive covenants and Cavendish sought to enforce clauses 5.1 and 5.6.  The effect of these clauses meant that M was potentially liable for a loss totalling $44million.  In his response to the claim, he argued that both clause 5.1 and 5.6 were penalties and therefore not enforceable.  

Read part two of this blog to be published on Wednesday 23 March to find out what happened when the cases reached the Supreme Court…