Liability of Sub-Contractors for Liquidated Damages Under JCT

MJD Solicitors see many disputes on liquidated damages (LADs). The permutation for disputes on LADs is endless. But what is the liability of sub-contractors for liquidated damages under JCT? How and why does the sub-contractor become liable for liquidated damages under JCT?

To answer the question, it is necessary to first consider the issue of liquidated damages under the Main Contract.

Liquidated Damages under the Main Contract 

Liquidated damages are a pre-agreed, fixed sum of damages, or compensation, that become payable on the occurrence of an event outlined in the contract.

In construction contracts, the application of LADs usually involves delay.  It can apply to other events in addition to delay, but that is an issue outside of this note.

When acting for a main contractor, the LAD dispute often concerns the Contractor’s entitlement to an extension of time, or EOT.

The Contractor will invariably argue that the employer has not awarded an appropriate EOT, and/or that time is at large.

The Contractor may question the validity of the LAD clause. The Contractor may argue that the level of liquidated damage means it is unenforceable.

Questions that may arise include: is the LAD an illegitimate penalty; is the LAD a genuine pre-estimate of loss; is the LAD disproportionate to the interest it is designed to protect against?

Whether the clause imposes such a disproportionate detriment on the contract-breaker involves consideration of whether the detriment (in the context of an LAD clause, the sum of damages payable) is extravagant or unconscionable, in comparison to the value of the legitimate interest.

The onus lies on the party alleging that the clause is a penalty to show that the relevant secondary liability – the LAD – is extravagant or unconscionable. See the combined Supreme Court cases of Cavendish Square Holding BV v Talal El Makdessi and ParkingEye Ltd v Beavis.

The Supreme Court rejected the formerly long-standing test for penalty clauses set out in Dunlop Pneumatic Tyre Co v New Garage & Motor Co Previously, the key issue in determining the legitimacy of an LAD clause was whether the amount payable represented a “genuine pre-estimate of loss”. However, the Supreme Court considered that this question is still useful in deciding whether the amount payable was extravagant or unconscionable.

To avoid being a penalty, the LADs must not be disproportionate to the employer’s likely loss in the event of late completion of the works under the building contract. This does not mean that the LADs payable under the contract must be a similar amount to the actual losses likely to be suffered by the employer, but they must not be excessive by comparison.

Courts have historically been keen to enforce LADs provisions and have allowed generous margin for error in the estimation of probable losses, especially where the likely damage is difficult for the parties to predict.

As the court in Dunlop Pneumatic Tyre noted, it may indeed be in cases where the precise prediction of damages is almost impossible that parties would have agreed to LADs clauses.

In ParkingEye, the Supreme Court even recognised that LADs clauses can exceed genuine pre-estimates of loss if doing so protects legitimate business interests. Consequently, an £85 fine for overstaying a parking time limit was enforceable, as it allowed ParkingEye’s to efficiently manage their car parks.

The courts are generally strict in their application of LADs clauses and will, where possible, uphold the contractual terms fixing the level of LADs in respect of a breach of contract.

A simpler challenge may exist where the Contract Particulars are completed incorrectly. Examples of wrongfully complete LAD Contract Particulars that we have seen include:

• no start date or completion date,
• LADs being described as nil,
• LADs being particularised as calculated annually, with no pro-rata provision.

In these circumstances the LAD provision may fall down as inoperable. If the LAD provision is unenforceable in the Main Contract, then it obviously cannot flow through to the Sub-Contract.

For this note, we will assume that the Contract Particulars have been completed correctly and there is no challenge to the validity of the LADs.

The JCT DB 2016 Conditions Precedent to Applying Liquidated Damages.

It is generally considered there are three conditions precedent that must satisfied before an Employer can apply LADs against the Main Contractor under the JCT Design and Build Contract.

If any of these conditions precedent have not been satisfied, then there can be no deduction of LADs, at least until the condition precedent has been satisfied.

Clause 29 – Payment or allowance of liquidated damages

2.29      

.1            Provided:

.1            the Employer has issued a Non-Completion Notice for the Works or a Section; and

.2            the Employer has notified the Contractor before the due date for the final payment under clause 4.24.5 that he may require payment of, or may withhold or deduct, liquidated damages,

the Employer may, not later than 5 days before the final date for payment of the amount payable under clause 4.24, give notice to the Contractor in the terms set out in clause 2.29.2.

.2            A notice from the Employer under clause 2.29.1 shall state that for the period between the Completion Date and the date of practical completion of the Works or that Section:

.1           he requires the Contractor to pay liquidated damages at the rate stated in the Contract Particulars, or lesser rate stated in the notice, in which event the Employer may recover the same as a debt; and/or

.2           that he will withhold or deduct liquidated damages at the rate stated in the Contract Particulars, or at such lesser stated rate, from sums due to the Contractor

.3           If the Employer fixes a later Completion Date for the Works or a Section, the Employer shall pay or repay to the Contractor any amounts recovered. allowed or paid under clause 2.29 for the period up to that later Completion Date.

.4            If the Employer in relation to the Works or a Section has notified the Contractor in accordance with clause 229.12 that he may require payment of, or may withhold or deduct, liquidated damages, then, unless the Employer states otherwise in writing, clause 2.29.1.2 shall remain satisfied in relation to the Works or Section, notwithstanding the cancellation of the relevant Non-Completion Notice and issue of any further Non-Completion Notice.

For the Employer to deduct liquated damages he must:

• serve a Notice of Non-Completion,
• notify that he requires payment of liquidated damages,
• serve the notice under clause 2.29.2 advising of the LADs deduction. If the Employer wishes to deduct monies from an amount otherwise due pursuant to a valuation, he will also have to serve the requisite Notice to Pay Less.

If the Employer does not serve these notices, then he cannot deduct liquidated damages until he has served the relevant notice.

The level of LADs pursuant to the JCT Main Contract and its calculation will be as prescribed in the Contract Particulars.

But what of the JCT Sub-Contract? What is the liability of sub-contractors for liquidated damages under JCT?

Liability Of Sub-Contractors For Liquidated Damages Under The JCT Design and Build Subcontract 2016

There is no equivalent LADs provision in the JCT Sub-Contract. The LADs that are particularised in the Main Contract are not set out in the same way in the Sub-Contract.

Liquated damages under the Main Contract are generally considered to be an exclusive remedy for delay.

That is not the case in the Sub-Contract, where the Sub-Contractor is potentially liable not only for the Main Contract LADs, but also all other losses and expenses incurred by the Main Contractor. The potential liability for the sub-contractor is significant.

What does the Design and Build Subcontract 2016 say about liability of sub-contractors for liquidated damages under the JCT?

Clause 2 .21 – Failure of Sub-Contractor to complete on time.

2.21       If the Sub-Contractor fails to complete the Sub-Contract Works or such works in any Section within the relevant period or periods for completion, and if the Contractor gives notice to that effect to the Sub-Contractor within a reasonable time of the expiry of the period or periods, the Sub-Contractor shall pay or allow to the Contractor the amount of any direct loss and/or expense suffered or incurred by the Contractor that is caused by that failure.

The JCT Design and Build Subcontract 2016 Guide which accompanies the JCT Contract spell out the consequences of this clause:

111        If the Sub-Contractor fails to complete the Sub-Contract Works or part of them within the relevant period or periods and the Contractor gives him the requisite notice, the Sub-Contractor is required to pay the Contractor his loss and expense arising from the failure. This, in addition to including other Sub-Contractors’ loss and expense, may where relevant include liquidated damages payable under the Main Contract.

Note I have emphasised the extent of the potential liability to the sub-contractor.

The Sub-Contractor’s liability for delay under the JCT is not confined to clause 2.21. It is necessary to also consider the wide indemnity under clause 2.5.1 of the Sub-Contract for a breach of the Sub-Contract. As is explained in the JCT Guide:

92          Under clause 2.5.1 the Sub-Contractor is required to observe, perform and comply with the Contractor’s obligations under the Main Contract (as identified in the Main Contract information Schedule to the Agreement) and to indemnify him in respect of any liability arising from the Sub-Contractor’s (or his employees’ or agents’) failure to do so.

 Clause 2.52 contains a further indemnity to the Contractor in respect of negligence or breach of duty by the Sub-Contractor, his employees or agents.

93           These are general indemnities to the Contractor under which the Sub-Contractor’s liability may include the Contractor’s costs, liquidated damages due to the Employer and payments to third parties to whom the Contractor is liable, whether in the form of others on site or members of the public.

 Being indemnities, these provisions may increase the liability of the Sub-Contractor to the Contractor for costs, losses and expenses beyond the amount which might otherwise be re coverable for breach of the Sub-Contract. Liability is potentially unlimited: the Parties may expressly agree that it should be limited by way of an overall cap but there is no provision for such a cap in the Agreement or Conditions.

If the Sub-Contract is completed properly by the Main Contractor, the Main Contract Particulars will be included as a Numbered Document (as required by Paragraph 6 of the Main Contact Information Schedule).

Therefore, the Sub-Contractor is unlikely to be able to argue he was not aware of the level of Main Contract LADs. If the Sub-Contractor delays the Main Contract Works, then the losses are entirely foreseeable. 

As Paragraph 93 of the Guide says, there is no cap on the liability of the Sub-Contractor. The liability is unlimited. I suggest it would be unusual for the Main Contractor to accept a cap on the Sub-Contractor’s liability. The Sub-Contractor must be liable for the full consequences of its breach of contract.

The potential liability of the Sub-Contractor under the JCT Sub-contract is therefore significant. I do not consider this to be peculiar to the JCT. Whenever MJD Solicitors draft sub-contracts for main contractors, we would ensure similar provisions are replicated.

Prima facie, the liability of the Sub-Contractor for LADs after a delay is a huge problem. The potential liability far exceeds the level of liquidated damages. The question is, what is the extent of a sub-contractor’s liability in reality?

Sub-Contractor Defences to claims for LADs and delay Damages.

In our experience, the Main Contractor will not claim damages from the Sub-Contractor for delay until either the parties are in dispute on another matter, or the sub-contract works are virtually complete.

When the Main Contractor has decided to claim damages from the Sub-Contractor, the Sub-Contractor’s interim application for payment will be responded to by a Pay Less Notice.

The Main Contractor reduces entitlements by reference to the Main Contract liquidated damages and other prolongation costs. The Sub-Contractor’s entitlements may be reduced to virtually nil. Often works are far from complete, and the Main Contractor has not even suffered any LADs.

The Sub-Contractor should, in the above circumstances, seek advice on what it should next do. In our experience, if the Sub-Contractor interrogates the withholding, it will discover that it has no proper basis. If an adjudication were commenced, the deductions may be reduced to nil.

It is not uncommon for contractors to apply delay deductions against several sub-contractors at the same time. The Contractor may or may not have suffered the imposition of liquidated damages under the Main Contract.

Often the Main Contractor is simply seeking to balance its books on a specific contract. In our experience, the Main Contractor’s project team often genuinely believes that the Sub-Contractor is to blames and reports this to head office management; the project team are often unable to take an impartial view.

When the Sub-Contractor is faced with a Pay Less Notice from the Main Contractor asserting liability for liquidated damages under the JCT, what questions should the Sub-Contractor be asking in order to establish the legitimacy, or not, of the LADs?

We suggest the following non-exhaustive matters should considered:

• Have the Main Contract LADs been successfully passed down into the Sub-Contract?
• Is the Sub-Contractor entitled to an Extension of Time?
• Is time at large under the sub-contract?
• Has the Main Contractor caused the Sub-Contractor to be in delay?
• Has the Sub-Contractor caused the delay for which LADs are claimed?
• Was the Contractor already in delay?
• Are the Main Contract LADs valid?
• Has the Main Contractor suffered LADs?
• Are the prolongation costs justified and substantiated?
• Is the Main Contractor using the LADs as leverage to agree a final account?

In our experience, any of the above may defeat a claim for liquidated damages. 

It is easy for a Main Contractor to claim LADs from a Sub-Contractor. All the Main Contractor has to do is issue a valid Pay Less Notice. Often, when you look behind the Pay Less Notice, there is nothing of substance there.

If the Main Contractor is not willing to retract its deductions, then inevitably we would recommend adjudication.  

The purpose of this note was to consider the liability of sub-contractors for liquidated damages under JCT. The potential liability for sub-contractors is significant. In our experience, it is however much harder for a Main Contractor to make a compelling case to retain the liquidated damages.

If you are concerned about the liability of sub-contractors for liquidated damages under JCT, then we are confident that MJD Solicitors can help. To speak with Matthew Dillon on a no obligation basis telephone 07962 011779

Matthew Dillon LLB, Solicitor, MCIArb

MJD Solicitors

14 August 2023

This article is for information purposes, does not constitute legal advice and should not be relied upon. For terms and conditions of this article please read here.