Construction Matters: Liquidated Damages – Assessing whether a clause is an unenforceable penalty

At our seminar last week Tom Owen of Keating Chambers discussed the recent Supreme Court judgment in Cavendish Square Holding BV v El Makdessi and ParkingEye Ltd v Beavis [2015] UKSC 67 and its implications on liquidated damages clauses in construction contracts.

The Makdessi case related to whether clauses agreed in a contract between the parties were unenforceable penalties. In a construction context, that is a consideration that always had to be thought through when agreeing the level of liquidated damages that a contractor would have to pay for failing to complete a project by an agreed target completion date. If penal in nature (i.e. more than a genuine pre-estimate of loss) then such clauses would not be enforceable under the law pre-Makdessi.

In Makdessi the Supreme Court decided that the law on unenforceable penalties, which broadly meant that a liquidated damages clause should provide for a payment that is a genuine pre-estimate of loss, was "an ancient, haphazardly constructed edifice which has not weathered well.” What was decided in Makdessi is that the test for an unenforceable penalty should be reformulated. Considering whether a payment is a genuine pre-estimate of loss is no longer conclusive. What we must now look at is whether the payment is “exorbitant or unconscionable” and in considering that in a liquidated damages context you can look at the employer’s legitimate interest in ensuring that the target completion date is met.

In theory, what that will likely mean is that contractors will face a tougher task in persuading a court that an agreed liquidated damages clause is unenforceable as the threshold under this new test appears to be higher than that under the old law. Whether the Supreme Court’s attempt at defining the test gives clarity will remain to be seen.