A penalty is now to be regarded as: “a secondary obligation which imposes a detriment on the contract-breaker out of all proportion to any legitimate interest of the innocent party in the enforcement of the primary obligation.” The UK Supreme

A penalty is now to be regarded as:

“a secondary obligation which imposes a detriment on the contract-breaker out of all proportion to any legitimate interest of the innocent party in the enforcement of the primary obligation.”

The UK Supreme Court has reviewed the English law of penalties and re-formulated the test in a landmark judgment on two unrelated appeals heard together:

• Cavendish Square Holding BV – v – Talal El Makdessi (“Cavendish”); and
• ParkingEye Ltd – v – Beavis (“Beavis”).[1]

The two appeals did not involve construction matters. The judgment will nevertheless be of great interest to construction industry practitioners, including lawyers, when considering whether a liquidated damages clause is valid and so fixes the sum payable in the event of a breach of contract, or alternatively, is an unenforceable penalty. If it is a penalty, the innocent party will need to prove his damages at common law.

Practitioners should note that the distinction has just become rather more clouded. The test provided 100 years ago has been replaced by more subjective considerations on which more guidance will inevitably be required from the courts. It may transpire that those certain types of construction employer, in seeking to protect a wide interest, may now seek greater sums in liquidated damages than previously.

Penalties are Secondary Obligations

The law regarding penalties is a rule of contract law based on public policy. A contract may not “punish” a contract-breaker. Penal provisions will therefore not be enforced by the courts. They have for a long time acknowledged that the law regarding penalties does not apply to primary contractual obligations. Save for circumstances involving illegality, duress, or questions of consent and the like, primary obligations are matters for the parties alone. The courts will generally not interfere; to do so would run counter to the parties’ freedom of contract.

Only secondary obligations that respond to a breach of contract may be subject to the law on penalties. The most obvious example of a secondary obligation is one whereby the contract-breaker must pay money in the form of liquidated damages to the innocent party. But, as we shall see, other secondary obligations may be equally amenable to the test for a penalty. For example, the requirement to transfer property or shares may also qualify as a penalty in the appropriate context.

Former Distinction Between Liquidated Damages and Penalty

In 1915, the House of Lords decision in Dunlop[2] famously underlined the dichotomy between a penalty and a liquidated damages provision in a contract. It was said to be ultimately a question of construction.

Dunlop held that the essence of a penalty was the payment of money stipulated as in terrorem of the offending party i.e. intended to deter a breach. In contrast, Dunlop also held that the essence of a valid liquidated damages provision was “a genuine, covenanted, pre-estimate of damage”. Anything that was not a genuine pre-estimate was at risk of being found penal after Dunlop. If the sum stipulated was “extravagant and unconscionable in amount in comparison with the greatest loss that could conceivably be proved to have followed from the breach”, it was definitely penal according to Dunlop.

Now, whilst the dichotomy between a penalty and a valid liquidated damages clause still exists as a matter of law, the boundary between the two has moved.

Cavendish v Makdessi

The Supreme Court case of Cavendish concerned an agreement for the sale of a majority shareholding by Mr Makdessi to Cavendish at a price per share that reflected very valuable goodwill. The agreement provided for stage payments; an initial payment to Makdessi followed by further payments calculated to reflect company profits when they were known. There was an anti-competition covenant that was later broken by Makdessi. In such circumstances, the agreement provided that Makdessi forfeited entitlement to the further payments and that he could also be required to transfer his remaining shareholding to Cavendish at a price per share stripped of the value of goodwill. Makdessi contended that the provisions, including that for the transfer of his remaining shareholding, were penalties and unenforceable.

The Supreme Court resisted a submission for the penalty rule’s complete abolition. However, it recognised many problems inherent in Dunlop. For example, secondary obligations following the breach of a primary obligation, particularly in modern commercial contexts, were said not always to be confined to the payment of money, contrary to the test set out in Dunlop. They might involve the forfeiture of a deposit in money or even the transfer of property e.g. in shares. It was said to depend on the nature of the right which the contract-breaker was being deprived of and the basis on which he was being deprived of it. The courts should be free to examine such secondary obligations to determine whether they are penal and therefore unenforceable, the Supreme Court said.

The Court was not unanimous in its categorisation of the provisions for the treatment of goodwill under Makdessi’s agreement. A minority decided that the provisions regarding loss of entitlement to further payments were not secondary obligations by Makdessi but were in fact part of a conditional primary obligation to pay by Cavendish. They were no more than a price adjustment mechanism whereby Makdessi, as the seller, effectively earned his future goodwill payments by not competing with the company he was selling. Goodwill was part of his consideration for the sale.  If it was not provided, Cavendish was not required to pay for it. Non-payment under the agreement did not amount to damages for breach of the anti-competition covenant. The law regarding penalties could not therefore apply, according to the minority. A majority of the Court however considered the forfeited payments were indeed secondary obligations on the part of Makdessi but were not penal for other reasons.

The distinction between what is a primary and a secondary contractual obligation and the prospect of “disguising” the true position in complex arrangements is therefore a potential problem for the future. Equally problematic may be the potential overlap between the common law right of an innocent party to withhold something otherwise due under an agreement, and the equitable remedy of relief against forfeiture available to a contract breaker.

The Law Lords in Cavendish also found the Dunlop concept of in terrorem, or deterrence, to be unhelpful. They said that an innocent party might have a legitimate interest in the performance of the contract by the other party which went well beyond the simple right to recover damages (i.e. financial compensation for breach) even if the damages could readily be calculated. There might be a wider purpose to the bargain; deterrence might be reasonable and appropriate to protect it.

Particularly in cases where the parties have access to legal advice and can negotiate on equal terms (as was the case with Cavendish and Makdessi), the Court considered that they should have the freedom to agree terms that were a deterrent to breach. Here the Court found that Cavendish and Makdessi placed a very high value on Makdessi’s accumulated goodwill. It was central to the bargain and Cavendish wanted to acquire it. Cavendish had a legitimate interest in protecting it. Once Makdessi had breached the anti-competition covenant, “the wolf was in the fold” as the lower court judge expressed it. The goodwill was effectively lost. Makdessi accordingly lost the entitlement to payment.

Furthermore, once this had happened, Cavendish had a legitimate interest in severing the relationship between the parties as quickly as possible. It could not proceed with a disaffected minority shareholder in Mr Makdessi. It was entitled to acquire the balance of Makdessi’s shareholding immediately and without the goodwill component, as provided for in the agreement. The requirement for the share transfer did not amount to a penalty.

For similar reasons the Supreme Court in Cavendish also thought unhelpful Dunlop’s requirement for a valid liquidated damages provision to be a genuine pre-estimate of loss that might flow from the breach.

Circumstances might mean that the amount to be paid following breach or other secondary obligation could not satisfy that strict test. As stated above, Dunlop had referred to a penalty in terms of the sum paid being “extravagant and unconscionable.” Similar phraseology is to be found in the review of more than 100 years of case law helpfully set out in Cavendish. One sees phrases such as “exorbitant”, “wholly disproportionate”, “gross excessiveness”, “unreasonable”, “manifest excess”, “extravagant disproportion” (and combinations of most of them) all used to describe a penalty provision over the years.

From this raft of egregious terms, the Supreme Court has distilled down the essence of a penalty. It has now approved the following succinct re-statement of the test. The test for a penalty now is:

“whether the impugned provision is a secondary obligation which imposes a detriment on the contract-breaker out of all proportion to any legitimate interest of the innocent party in the enforcement of the primary obligation.”.

ParkingEye v Beavis

ParkingEye managed the car park of a retail centre containing many individual stores. Signs throughout the car park stated that the first two hours’ parking by customers was free but those who parked for anything longer would incur an £85 single charge. The signs also stated that, by parking in the facility, motorists were agreeing to the above terms. Mr Beavis overstayed by almost one hour and was charged £85. In court proceedings brought by ParkingEye to recover the charge, Beavis alleged that it was unenforceable at common law because it was a penalty. He also alleged that it was unfair and unenforceable by virtue of the Unfair Terms in Consumer Contracts Regulations 1999 (“Regulations”).

The Supreme Court heard the scheme described as a “traffic space maximisation scheme”. The £85 charge clearly had nothing to do with compensating ParkingEye for Beavis’s breach. Its predominant purpose was in terrorem – to deter over-stayers – prohibited by Dunlop. The entire scheme benefitted the retailers who relied on the offer of two hours’ free parking to attract potential customers to the retail centre and on the £85 charge then to repel them, so ensuring that there was a regular turnover of visitors. The subsidiary purpose of the charge was to fund the scheme.

That benefited ParkingEye by allowing it to make a reasonable profit. Even the car park’s users benefitted from the scheme through having access to parking space that might otherwise be clogged up with vehicles not belonging to customers of the retail centre.

ParkingEye therefore was found to have a legitimate interest in the enforcement of the charge which was not out of line with those of other such schemes elsewhere in the UK. The charge was therefore not wholly disproportionate to that legitimate interest and not a penalty. Neither was it unfair under the Regulations.

Conclusion on the Implications of Cavendish and Beavis

The concept of penalty remains, but the point at which it is reached has become more elastic. It would seem that with the disappearance of the emphasis on requiring a genuine pre-estimate of loss, there is now scope for liquidated damages to exceed previous levels. Some deterrence is in principle now acceptable.  So long as there is a legitimate interest in enforcement of the original obligation and the sums stipulated are not “out of all proportion” and unconscionably so, the courts are likely to tolerate the level of damages agreed. Much uncertainty, however, remains:

• The distinction between primary and secondary obligations was unclear even to the seven-member bench assembled in Cavendish. For complex commercial matters, further guidance will be required on this question and on how one may identify a penalty masquerading as a primary obligation. In the commercial arena, one can now expect to see obligations framed as primary obligations so far as possible to render them immune from
• In the field of construction, a simple obligation to pay liquidated damages for completion after an agreed date is unlikely to be regarded as primary in nature. However, where differences in performance of the final product attract liquidated damages, depending upon how the provisions are drafted when looked at overall, there might be greater scope for such a finding.
• A further problem lies in the identification of what a legitimate interest is, and on its distinction from an “illegitimate” one. May an employer, say, a high-profile authority with responsibilities towards the general public, now argue that its interests entitle it to enforce a contractor’s obligation to pay liquidated damages for delay or under-performance far exceeding the “genuine pre-estimate of loss” which formerly it would have demanded?
• If so, the importance of an Employer’s “legitimate interests” in performance and the potential effects of a breach on those interests are best declared at the outset and set out clearly within the contract
• Given the considerations of the Supreme Court in Cavendish, in those circumstances it would also be sensible to include a declaration that the parties are of comparable bargaining power and have had access to legal

A still further problem resides in determining what constitutes a detriment “out of all proportion” to a legitimate interest. Which, if any, of the superlatives may still be relied upon now for further guidance? Lord Mance considered them to be “extravagant, exorbitant or unconscionable”, at least in cases where the parties were not of equal bargaining power and properly advised.

Please get in touch at victoria.tyson@howardkennedy.com with your thoughts or to discuss any concerns.

[1] [2015] UKSC 67.

[2] Dunlop Pneumatic Tyre Company Ltd v New Garage & Motor Company Ltd [1915] AC 79 (“Dunlop”).

There is a substantial difference between the payment provisions of the FIDIC 1999 Red and Yellow Books compared with the Silver Book. This article explores how a court in Queensland (Australia) dealt with the Silver Book’s provision. Contractors have good

There is a substantial difference between the payment provisions of the FIDIC 1999 Red and Yellow Books compared with the Silver Book. This article explores how a court in Queensland (Australia) dealt with the Silver Book’s provision. Contractors have good cause to be wary.

Role of Interim Payment Certificate

In Dawnays Ltd v F G Minter and Trollope & Colls Ltd,[1] the English Court of Appeal judge, Lord Denning, expressed the view that: “an interim certificate is to be regarded virtually as cash, like a bill of exchange.” This bold statement was however quickly rejected by the higher English courts.

Viscount Dilhorne of the House of Lords held in Gilbert Ash (Northern) Ltd v Modern Engineering (Bristol) Ltd[2] that there was “no scintilla of authority” for Lord Denning’s opinion. Viscount Dilhorne went on to say that treating a certificate as conclusive could easily cause injustice. Lord Diplock added that, although a correctly issued interim certificate does create a debt due from the employer to the contractor, it does not stop the employer from raising a set-off or cross claim to the sum due.

The Irish judiciary was equally dismissive. In John Sisk & Son v Lawter Products BV[3] the Irish High Court disagreed with Lord Denning’s “dogmatic proposition” and considered that the correct approach was to ascertain whether the terms of the particular contract were inconsistent with the exercise of a right of set-off by the employer.

The position in England has since changed with the introduction of the payment provisions within the Housing Grants, Construction and Regeneration Act 1996, as amended by the Local Democracy, Economic Development and Construction Act 2009. Now a paying party must pay the notified sum unless it has served a “Pay Less Notice”. In summary, the payer must now give notice of what it intends to set off and loses its right of set off if the notice is not given. FIDIC’s Silver Book has a very different regime.

Set-Off and Deduction Under FIDIC

The payment provisions in FIDIC’s Red and Yellow Books are dealt with in Clause 14. The contractor submits an application for payment and the engineer, under Sub-Clause 14.6, “fairly” determines what is due. Sub-Clauses 14.6 (a) and (b) allow the engineer to make certain deductions where the work done is not in accordance with the Contract, or the contractor has failed to perform its obligations. Under Sub-Clause 14.7, the employer is required to pay the amount certified in each Interim Payment Certificate.

Under FIDIC’s 1999 Silver Book the contractor submits an application for payment and the employer is required to give notice to the contractor within 28 days of any item which he disagrees with. Similar to the Red and Yellow Books, Sub-Clauses 14.6(a) and (b) allows the employer to make certain deductions where the work done is not in accordance with the Contract or the contractor has failed to perform its obligations. Sub-Clause 14.6 then states, “Payments due shall not be withheld“.

Silver Book’s ‘Payment Due’ Provisions Under Court Scrutiny

In Sedgman South Africa (Pty) Ltd and Ors v Discovery Copper Botswana (Pty) Ltd,[4] the Supreme Court of Queensland analysed the meaning of Sub-Clause 14.6 of FIDIC’s Silver Book and, in particular, what was meant by the words “payments due”.

The facts of Sedgman were that Sedgman contracted to design and construct parts of the Boseto Copper Project in Botswana for Discovery Copper. The contract was under an amended FIDIC Silver Book. Sedgman applied for an interim payment of USD 20 million. Sub-Clause 14.6 (as amended) required Discovery Copper to give notice within seven days if they disagreed with any items in the application for payment. Discovery Copper failed to give the notice within seven days and did not contest the application until fourteen days later. Sedgman applied to the Court for payment of the sum claimed.

Discovery Copper challenged Sedgman’s right to payment on three grounds:

• The claim was not served in the format specified by the contract.
• According to the proper interpretation of the contract, the absence of a specific notice within seven days challenging the claim did not automatically entitle the applicants to the amount claimed.
• The application to the Court for payment should be stayed to arbitration as the contract contained an arbitration clause.

Sedgman sought to argue that it was clear that they were entitled to payment and that there could be no genuine dispute over the sum claimed.

Only payments ‘due’ need be paid

The Court dismissed Sedgman’s application for payment, holding that there was a genuine dispute which was apt for determination under the dispute resolution provisions and that Sedgman’s interpretation of the contract was incorrect. The Court held that:

“This contract did not entitle the applicants to be paid the sum which they now claim, simply from the fact that there was no response to their interim claim within the period of seven days stipulated in the contract.”

McMurdo J in his judgment considered the words “payments due shall not be withheld” at Sub-Clause 14.6 of the contract. The Judge stated that these words were “different from saying that a payment will become due if a notice of disagreement is not given,” as Sedgman contended. The Judge then held:

“The alternative view of Sub-Clause 14.6 is that it does not make a payment due. Rather, it governs payments which, by the operation of another term or terms, have [already] become due.”

The Judge stated in his reasoning that that operation of the various clauses of the contract to determine claims and variations could otherwise be displaced by the operation of Sub-Clause 14.6, if Sedgman were correct. If the contractor included a claim in his application for payment which was inconsistent with, for example, a DAB’s determination, and the employer did not give notice of disagreement, the outcome would be that the DAB’s determination would be displaced.

The conclusion reached by McMurdo J was that Sub-Clause 14.6 had to be read in the context of the whole contract. He fundamentally disagreed with the assertion by Sedgman that if the notice of disagreement was not given within seven days, then “everything that had occurred between the parties about these components of the present claim was made irrelevant.” The Judge therefore rejected the idea that claims which may have been disallowed or in contention between the parties could become debts simply because the notice was not given on time.

Silver Book payment provisions favour the employer

There is therefore a substantial difference between the payment provisions of the Red and Yellow Books compared with the Silver Book. While Sub-Clause 14.6 of the Red and Yellow Books obliges the employer to pay to the contractor the “amount certified in each interim payment certificate”, the Silver Book only requires the employer to pay “the amount which is due in respect of each statement.” The amount which is due is not the sum claimed by the contractor, but the sum which is determined by applying all the provisions relating to payment. The sum claimed is therefore open to dispute.

Conclusion

The decision in Sedgman has a number of practical consequences. One example relates to termination. Under Sub-Clause 16.2(c) of the Red and Yellow Books, a contractor may terminate the contract where it does not receive the amount due under an Interim

Payment Certificate. Under Sub-Clause 16.2 (b) of the Silver Book, the contractor may terminate where it does not receive the amount due in the period which payment is to be made.

However, a contractor must now be extremely careful because the amount due can only be determined by applying all the provisions relating to payment. Under the Silver Book, an employer is in a much stronger position if it wishes to withhold money. There is no quick way for the contractor to get paid without going through the dispute resolution provisions. If, as stated by Lord Denning, “cash flow” is the very “lifeblood” of the construction industry, then a contractor needs to be wary of the Silver Book’s payment provisions.

Please get in touch at victoria.tyson@howardkennedy.com with your thoughts or to discuss any concerns.

[1] [1971] 1 WLR 1205.

[2] [1973] 3 All ER 195.

[3] [1976-1977] 204.

[4] [2013] QSC 105.

Clause 1.15, previously in Sub-Clause 17.6 (1999 Edition), is now separated from Risk and Responsibility. It exempts parties from liability for loss, including loss of use, profit, or contracts, with exceptions for certain sub-clauses, notably Sub-Clauses 8.8 and 13.3.1(c).

The substance of this provision was already in Sub-Clause 17.6 in the 1999 Edition and has now been separated from other provisions dealing with Risk and Responsibility.

As before it generally exempts parties from liability to the other for “loss of use of any Works, loss of profit, loss of any contract or any indirect or consequential loss” except in respect of a list of identified Sub-Clauses. The list has been extended and several of the changes are very significant. It also limits liability to certain levels in some circumstances. Finally, it excludes parties from cover by the exemption and limits in certain circumstances. All three elements have changed.

Two additions are particularly noteworthy. The interaction between this Sub-Clause and Sub-Clause 8.8 insofar as it relates to the liability- limiting effect of Delay Damages is confusing, and it is very unclear what the final result should be taken to mean. There is also a similar lack of clarity in the way in which the Sub-Clause applies the exemption to Sub-Clause 13.3.1(c) (proposals for valuation of variations).

Exceptions to exemption from liability to the other party for loss of use of any Works, loss of profit, loss of any contract or any indirect or consequential loss

The list of exceptions to the exemptions from liability in the 1999 Edition extended to only 2 items (Payment on Termination and Indemnities). It is now extended to some additional items.

It should be noted that the wording of the Sub- Clause goes further than merely to negate the exemption from of liability for these items. It says that “neither party shall be liable for loss of profit” etc. … “other than under…”. Thus, if the party can show such loss, it confers an express right to claim such loss. Normal rules of the underlying law of the contract (unless mandatory) are thus excluded. Where the Sub-Clause to which the exception applies clearly sets out the loss

or damage which this exclusion from exemption refers to this does not raise an issue. However, there are issues in respect of the cross reference to Sub-Clauses 8.8 and 13.3.1(c).

The new items are:

• Sub-Clause 8.8 [Delay Damages]
• Sub-paragraph (c) of Sub-Clause 13.3.1 [Variation by Instruction]
• Sub-Clause 15.7 [Payment after Termination for Employer’s Convenience]
• Sub-Clause 16.4 [Payment after Termination by Contractor]
• Sub-Clause 17.3 [Intellectual and Industrial Property Rights]
• Limit on Total Liability
• Exclusion from Limits on Liability

Sub-Clause 8.8 [Delay Damages]

Sub Clause 8.8 already states that

“this Sub-Clause shall not limit the Contractor’s liability for Delay Damages in any case of fraud, gross negligence, deliberate default or reckless misconduct by the Contractor.”

Thus, if the Contractor is guilty of one of these types of misbehaviour, it will not be able to take advantage of the cap on Delay Damages. The lifting of the limitation in the Sub-Clause partly duplicates the last paragraph of Sub-Clause 1.15. This paragraph also lifts the limit in such circumstances, but goes further in allowing the general limit of liability under the Contract to be exceeded.

As noted above, Sub-Clause 1.15 is divided into two parts. The first lifts the exclusion of liability for loss of profit etc. The second lifts the limits of liability under the Contract.

The reference to Sub-Clause 8.8 in Sub-Clause 1.15 is under the first part and thus is intended to remove the exemption from liability for losses of profit when applying Delay Damages. Since Sub-Clause 8.8 provides that Delay Damages are the only damages due from the Contractor for failure to meet the Completion Date, except in the event of Termination under Sub-Clause 15.2 [Termination for Contractor’s Default] it would therefore seem that the exclusion is intended to prevent arguments that Delay Damages incorporate loss of profits and to allow for the possibility of loss of profit claims in the event that the Contractor is terminated for cause. If the latter were the case, one would have thought that Sub-Clause 1.15 would include Sub- Clause 15.2 (or more correctly Sub-Clause 15.4) in the list. There may however be an argument that an Employer is now entitled to claim loss of profit following termination for cause.

Sub-paragraph (c) of Sub-Clause 13.3.1 [Variation by Instruction]

13.3.1(c) is the provision which requires the Contractor, when carrying out a Variation instruction, to provide the Engineer with a proposal for adjustment of the Contract Price. It specifically sets out the right to include any costs resulting from the omission of any work. In particular it allows the Contractor to claim loss of profit, and other losses or damage it suffers, when it has agreed that work should be omitted to be carried out by others.

A simple reading would say that the exception to the normal exclusion is only intended to apply to the Contractor’s rights following an agreed omission in circumstances where the omission was ordered so that the work could be carried out by others. However, the exception is more widely expressed. It does not seem possible to read it down to prevent the Contractor claiming for loss of profit etc. as part of the costs it incurs in the case of any omission.

However Sub-Clause 13.3.1(c) does not only cover omissions. It also covers all adjustments to the Contract Price following variations. It would thus seem arguable that the Contractor is entitled to include loss of profit etc. in all its Variation valuation proposals, if there is a basis for it in the circumstances. For example, a very substantial Variation, which the Contractor is required to carry out on the basis of rates which cause it a loss, or which forces it to use resources that might have been more profitably employed elsewhere, might open the door to a claim for the loss of profit etc.

It is doubtful that it was FIDIC’s intention to open the door to such arguments. However, the reading of the Contract which leads to this conclusion is a reasonable one, and it is altogether possible that a tribunal confronted with the issue will reach this conclusion.

See comment on the last paragraph of 1.15 below for the consequences as regards non-consensual omissions intended to allow the Employer to have the work completed by others.

Sub-Clause 15.7 [Payment after Termination for Employer’s Convenience]

Sub-Clause 15.6 in the new Edition is a significant departure from the 1999 Edition, in that it gives the Contractor entitlement to claim “loss of profit and other losses and damages suffered by the Contractor as a result of this termination”. Sub-Clause 15.7 only refers to the obligation to pay the amount certified under Sub-Clause 15.6. The exception ought to have referred to Sub-Clause 15.6, though the intention is obvious. It is notable that 15.6 only refers to “loss of profit and other losses and damages”, whereas 1.15 allows claims for “loss of profit, loss of any contract or any indirect or consequential loss”. Thus, Sub-Clause 1.15 appears to have the effect of expanding the categories of loss which might have been claimable on a reading of Sub-Clause 15.6 standing alone.

Sub-Clause 16.4 [Payment after Termination by Contractor]

Sub-Clause 16.4 already includes a right to payment of loss of profit although it also refers only to “loss of profit or other losses or damages”. As with Sub-Clause 15.7, there may be scope for a wider claim.

Sub-Clause 17.3 [Intellectual and Industrial Property Rights]

Under Sub-Clause 17.3, the Employer and the Contractor each indemnify the other against any claims which may arise where the other faces a claim resulting from a breach of intellectual or industrial property rights caused by the other. The purpose of this exception is presumably to overcome any suggestion that the costs the indemnified party faces are excluded as indirect or consequential.

Limit on Total Liability

This provision was in the 1999 Edition and is to the same effect.

Exclusion from Limits on Liability

This provision prevents the parties escaping from liability in the case of fraud, gross negligence, deliberate default or reckless misconduct. The term “gross negligence” has been added to the 2017 Edition version.

This may have substantially different results depending on which Law applies to the contract.

In an interesting treatment of the subject recently presented to the Society for Construction Law in London,[1] the authors quoted a passage from the Court of Appeal in Armitage v Nurse[2] :

“It would be very surprising if our law drew the line between liability for ordinary negligence and liability for gross negligence. In this respect English law differs from civil law systems, for it has always drawn a sharp distinction between negligence, however gross, on the one hand and fraud bad faith and wilful misconduct on the other… we regard the difference between negligence and gross negligence as merely one of degree … civil systems draw the line in a different place. The doctrine is culpa lata dolo aequiparatur [gross negligence is equal to fraud]; and although the maxim itself is not Roman the principle is classical. There is no room for the maxim in the common law.”[3]

However as far as the English Law is concerned, the Courts will recognise an express contractual agreement that gross negligence (rather than mere negligence) will attract liability.

The distinction between ordinary and gross negligence is not easy to define in abstract terms, and the authors of the SCL paper after considering numerous authorities have suggested the following set of tests.

“52. However, where the term is not defined (which seems to be more usual), then we suggest the authorities identify the following seven factors as relevant to determining whether “gross” negligence has occurred:

1. Was the nature of the error serious, involving a high degree of risk?
2. Was the conduct undertaken with an appreciation of the risks, but with a blatant disregard of or indifference to an obvious risk?
3. That disregard or indifference need not be conscious, or deliberate; it is sufficient that the reasonably competent professional in the defendant’s position would have considered the action or inaction to amount to a blatant disregard of or indifference to the relevant risk. Conscious disregard/recklessness will however be a likely aggravating factor, and more likely to led to a finding of gross negligence.
4. Were the potential consequences of the action or inaction serious? The more serious the consequences, the more likely the negligence will be gross.
5. Had the same or similar consequences arisen out of the same or similar action or inaction before? In other words, was it a repeat error?
6. How likely was it that the consequence would occur? Again, the more objectively likely it was to occur, the more likely a finding of gross negligence.
7. What precautions were taken (if any) to prevent the consequence occurring? The more obvious and modest the steps, and the greater and more likely the risk, the more likely it is that the conduct in question will veer towards gross negligence.”

Thus, the test to be applied under common law systems before deciding whether a party can escape from liability differs considerably from that under civil systems. In the former, a high degree of negligence will make a party liable, but in the latter, only fraud will enable them to escape. It may well be that some common law and civil systems apply a different test, and parties will need to take local legal advice before deciding what the limitation on exclusion means in practice.[4]

Apart from this surprising change, it should be noted that the exclusion probably does not prevent a Contractor faced with a non-consensual omission by the Engineer to allow the Employer to have the works carried out by others from claiming loss of profit. Such an omission is forbidden under Sub-Clause 13.1, unless the Contractor agrees. It would therefore be a breach of contract on the Employer’s part: any loss would be recognised in damages. Since the breach would be deliberate, the Employer would not be entitled to protection from a claim for loss of profit.

Please get in touch at victoria.tyson@howardkennedy.com with your thoughts or to discuss any concerns.

[1] Exclusions from Immunity: Gross Negligence and Wilful Misconduct, James Pickavance and James Bowling SCL October 2017.

[2] [1997] EWCA Civ 1279, [1997] 2 All ER 705, [1997] 3 WLR 1046.

[3] Armitage v Nurse Note 14 [1997] 3 WLR 1046 para [254].

[4] In the Guidance included in the 2017 Edition FIDIC notes that “under a number of legal systems (notably in some common law jurisdictions) the term ‘gross negligence’ has no clear definition and, as such, is often avoided in legal documents.” In the general commentary on the definitions, it is suggested that a typical additional definition might be “Gross Negligence means any act or omission of a party which is contrary to the most elementary rules of diligence which a conscientious employer or contractor would have observed in similar circumstances, and /or which show serious reckless disregard for the consequences of such an act or omission. It involves materially more want of care than mere inadvertence or simple negligence.” Although one might wonder what the difference is between “serious reckless disregard” and “reckless disregard”, it would seem to be sensible to include a definition of what is meant by “gross negligence” and this definition has the benefit of improving the level of certainty.