How tribunals in South Africa might assess limitations on liquidated damages

Why are liquidated damages clauses used?

Liquidated damages are an agreed fixed sum that the employer in a contract for construction works can recover in the event there is a delay in completing the work which is the contractor’s fault or for which the contractor has taken the risk. An employer is entitled to recover liquidated damages in the agreed amount without having to prove the loss that has been suffered.

Liquidated damages clauses are a common feature of both standard form and bespoke construction contracts, and are intended to provide certainty to both the employer and contractor in the event that the works are delayed by reason of contractor default.

In the absence of an agreed or enforceable liquidated damages clause the employer is left to pursue a common law claim for its actual proven loss where the term of the contract to complete the works by the completion date is breached.

Proving the nature and extent of those damages is notoriously difficult and requires evidence to show what the appropriate sum is to put the employer back in the position as if the contract had been performed on time. This type of assessment inevitably brings into sharp focus issues around the foreseeability and remoteness of any losses suffered by the employer.

Contractors are equally, if not more, exposed by the absence of a liquidated damages clause. A contractor’s liability at common law is highly unpredictable, mainly because the assessment of what are considered to be “unforeseeable” or “remote” losses is conducted on a case-by-case basis. There is consequently the real risk that significant losses may be recoverable against a contractor at common law for which it has not bargained.

Specifying the circumstances in which damages for delayed performance are payable, and the amount of those damages, is beneficial to both parties as, the UK Supreme Court has put it, “[e]ach party is therefore better able to manage the risk of delay in the completion of the project”.

Liquidated damages clauses may fail

However, there are situations where a liquidated damages clause may be ineffective, even if the parties have agreed to it.

Under English law, the most common exceptions in respect of commercial contracts are where the liquidated damages clause is either: vague or uncertain; or a penalty – the broad test for the latter being whether the sum stipulated is exorbitant or unconscionable having regard to the innocent party’s interest in the performance of the contract.

Similarly, under South African law the most common is the application of the Conventional Penalties Act, which is aimed at preventing excessive penalties being enforced or extracted that are out of proportion to the prejudice actually suffered by the creditor.

To avoid these sorts of argument, parties will usually include provisions in the contract designed to preserve the sanctity of the liquidated damages clause. Such measures might include, for example, that the liquidated damages represent a genuine pre-estimate of the employer’s loss, or that the liquidated damages clause is the sole and exclusive remedy for delay.

It is less common to see provisions setting out what the contractor’s liability for damages on account of delayed performance will be, where the liquidated damages clause falls away.

The consequences of failure of a liquidated damages clause

A liquidated damages clause may be held to be unenforceable. In that scenario, if the parties have not otherwise catered for the contractor’s liability expressly, it may not be clear whether the liquidated damages clause, notwithstanding that it is unenforceable, acts to limit the contractor’s liability at common law.

Guidance on this issue was provided by two High Court judges in England and Wales, in separate rulings handed down in 2021 and 2022 respectively.

In the first case, a developer, ECO World, appointed Dobler as its contractor for façade and glazing works at a site in London. The contract provided that if Dobler failed to complete the works by the relevant date for completion, ECO World could give notice for the payment or withholding of liquidated damages at a rate of nil per week for the first four weeks of delay, and thereafter at a rate of £25,000 per week up to an aggregate of 7% of the final contract price.

The works were not completed by the completion date, and two out of the three blocks being constructed were subsequently partially possessed by ECO World. The remainder of the work to all three blocks was certified as complete some eight months later.

ECO World sought to circumvent the liquidated damages provision in order to claim greater damages at common law, but Mrs Justice O’Farrell DBE held that the clause was enforceable and was not penal, notwithstanding the argument from ECO World that the clause did not provide a mechanism for reducing liquidated damages proportionately to the work taken over.

Whilst strictly the case ended there, the court went on to consider whether, had the liquidated damages provision been unenforceable/void, it would nevertheless act as a separate and independent limitation on liability. The court found that it did.

The judge said: “Each clause must be construed in accordance with the established principles of contractual interpretation summarised above. In my judgment, clause 2.32.1 and the Trade Contract Particulars would operate as a limitation of liability provision, even if the liquidated damages were void or a penalty … A literal reading of the provision suggests that the 7% cap would apply only to the liquidated damages and not to any general damages. However, the objective understanding of the parties in the commercial context of the Contract would be that the provision served two purposes: first, to provide for, and quantify, automatic liability for damages in the event of delay; second, to limit Dobler’s overall liability for late completion to a specific percentage of the final contract sum. The clear intention of the parties was that Dobler’s liability for delay damages would be so limited.”

In the second case, Mr Alexander Nissen QC considered the same issue in the context of a corrugated cardboard plant at Ellesmere Port to be constructed by Buckingham Group for the developer, Peel.

Here the contract contained a complex liquidated damages regime which Buckingham sought to have set aside for uncertainty. The uncertainty was said to arise as a result of drafting errors and also, similarly to ECO World, because of an unworkable partial possession regime. 

Mr Nissen QC found that the clause was not uncertain and could be operated and, whilst the outcome of the case was determined at that point, he, like Mrs O’Farrell QC in the ECO World case, also went on to consider whether the liquidated damages clause would have separately operated as a limitation on liability.

Adopting the same principles of contractual construction, Mr Nissen QC considered that the clause did not act to cap liability in general damages, only to liquidated damages.

The difference between the ECO World and Buckingham cases was the wording of the clause in question.

Penalties in South Africa

Under South African law, a liquidated damages, termed “penalty”, provision is considered against the same broad principles, albeit with the additional context of the Conventional Penalties Act 1962 (the Act).

In accordance with the Act, such a provision is enforceable as a contractual obligation, but:

• a creditor cannot recover in respect of both the provision and damages, or damages in lieu of the penalty, unless the contract so provides;
• an exception to the above is where the penalty is insufficient to cover the damages suffered, and then the innocent party may claim an additional amount as damages as long as the agreement in question expressly provides for the recovery of damages; and
• if the penalty is out of proportion to the prejudice suffered by the creditor, the amount may be reduced to such extent as is equitable.

The objectives of the Act are designed to assist with the enforcement of contracts while measuring this enforcement against the requirements of public policy.

In this way, the Act arguably adopts a fairer position than the “all or nothing” approach of English law to liquidated damages provisions, permitting the provision to be reduced proportionately to reflect the probable loss of the creditor accounting for its full interests. This exercise is, in practice, analogous to understanding a creditor’s losses for the purposes of a damages claim.

Therefore, where a penalty provision is reduced under the Act, an alternative damages claim is unlikely to be of any value to a creditor, even where the contract preserves such a claim, because the assessment of the reduction would have already taken into account the creditor’s actual foreseeable losses.

The consequence of this is that, under South African law, a penal liquidated damages provision will generally have some effect. For such a provision to be reduced to nil, it would likely have to be shown that the creditor incurred no loss at all. An alternative damages claim would obviously not improve that position for the creditor.

When considered against that context, the English court’s reasoning in the ECO World and Buckingham cases is unlikely to provide much assistance when looking at a liquidated damages provision from the point of view of a penalty, because South African law presciently caters for the situation through the Act.

Indeed, had the cases arisen in South Africa, they may well have been decided differently and the liquidated damages provisions would probably have been reduced to reflect the partial taking over by the employer.

Vagueness and uncertainty under South African law

The ECO World and Buckingham case law may, however, become instructive in South Africa where a liquidated damages provision is found to be void for uncertainty.

Like in England and Wales, South African courts adopt a unitary approach to the interpretation of contracts. According to the South African Supreme Court of Appeal: “The 'inevitable point of departure is the language of the provision itself', read in context and having regard to the purpose of the provision and the background to the preparation and production of the document.”

Under South African law, where the meaning of a provision is uncertain or vague it is treated as if it has not been written at all and is thus liable to be struck down. However, like the English and Welsh courts, tribunals in South Africa are slow to get to that position and will first strive to give meaning to the words used in the contract.

However, if the provision in question was deemed to be incapable of operating as a penalty in terms of the Act by reason of vagueness or uncertainty, the court would then be required to determine whether the provision was nevertheless sufficiently clear so as to operate as a limitation on any common law claim related to delayed performance and, if so, to what extent. Given the Act, it may also be necessary for the contract to expressly permit a claim in damages for late completion.

Here, the rulings in the ECO World and Buckingham cases demonstrate the importance of the specific words of the contract, when examined against the relevant background context. The Buckingham case shows that clauses can be drafted so as to clearly be applicable only to liquidated damages, whereas in the ECO World case the court’s conclusion stemmed from the parties’ presumed intentions and the purpose of the provision in question – both are relevant considerations of contractual interpretation under South African law.

The South African approach in summary

In light of the Act, the assessment of a penal and/or uncertain liquidated damages clause is a more nuanced exercise in South Africa than it is in England and Wales, and the outcomes in the ECO World and Buckingham cases would probably have been different had they been decided in South Africa.

What is clear though is that, similar to the position under English law, as long as the contract is clear as to how the penalty is to be determined and that this amount is readily ascertainable and understood by the parties, a limitation of the recovery of penalties and common law damages will be seen as enforceable.

However, owing to the similarities in the approaches to contractual interpretation in both jurisdictions, the guidance of Mrs Justice O’Farrell DBE and Mr Alexander Nissen QC demonstrates how a South African tribunal might go about assessing the efficacy of an unenforceable penalty provision as a separate limitation of liability.

Co-written by Rati Thobejane and Siyabonga Machava of Pinsent Masons.