| Date | 22 June 2005 |
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| Judgment | Alfred McAlpine Capital Projects Ltd v Tilebox Ltd, TCC 25 February 2005 |
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| The Issue | Interpretation of liquidated damages provisions and whether they represent a penalty. |
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| Implication |
Pre-estimated damages calculated for the purpose of a liquidated damages clause do not have to be right to be enforceable. The test for whether a clause is a penalty clause does not turn upon the honesty or genuine nature of a party making the estimate but is primarily an objective one. |
printIn 1998 a developer named Tilebox purchased a leasehold interest in a property in Guildford called Onslow House. At that time, Onslow House comprised about 50,000 square feet of space. The directors of Tilebox planned to strip the building to its core and completely refurbish it creating in the process approximately 90,000 square feet of space. The objective was to create a grade A top of the range building which would be suitable for use as headquarters by a substantial corporation. In February 2001 Tilebox entered into a development funding agreement with Standard Life. The agreement involved Tilebox surrendering its leasehold interest in Onslow House and Standard Life acquiring a long lease of the property for a price of £10 million. Tilebox were to enter into a building contract with Alfred McAlpine to carry out the substantial rebuilding works necessary at Onslow House, and Standard Life would fund the cost of this development subject to an agreed maximum figure. Tilebox would receive a management fee of £225,000 and a development completion payment calculated in accordance with a formula set out in the agreement. Negotiations between Tilebox and McAlpine took place during the spring of 2001. One of the matters discussed in these negotiations was the level of liquidated and ascertained damages which would be payable in the event of delayed completion of the works. Tilebox proposed £45,000 per week. This figure was calculated by Tilebox as representing the minimum weekly rental value of the completed building. McAlpine initially resisted this figure as being too high. However, there was give and take about numerous issues in the course of the negotiations and in the end McAlpine agreed to accept the figure of £45,000 per week. At the end of April of that year, Tilebox and McAlpine entered into a design and build contract in the JCT standard form providing for liquidated damages at that level. Unfortunately, very substantial delays occurred in the course of the works and against this background McAlpine became concerned about its potential liability to liquidated and ascertained damages. Delays in completion of almost two years meant that the liquidated damages had risen to a potential £5.4 million. McAlpine took legal advice and, having done so, formed the view that the rate of liquidated and ascertained damages specified in the building contract was excessive. They asserted that the provision was a penalty clause and therefore invalid. The matter came before Mr Justice Jackson in the Technology and Construction Court. Justice Jackson reviewed the relevant authorities relating to liquidated damages and concluded by making four general observations. Firstly, there seemed to be two strands to the authorities. In some cases, the judges had considered whether there was an unconscionable or extravagant disproportion between the damages stipulated in the contract and the amount of damages likely to be suffered. In other cases the courts simply considered whether the level of damages stipulated was reasonable. Justice Jackson commented that a pre-estimate of damages does not have to be right in order to be reasonable. There must be a substantial discrepancy between the level of damages stipulated in the contract and the level of damages which is likely to be suffered. Secondly, although many authorities use the phase "genuine pre-estimate", the test does not turn upon the genuineness or honesty of the party who made the pre-estimate. The test is primarily an objective one, even though the court will have some regard to the thought processes of the parties at the time of contracting. Thirdly, the rule about striking down penalty clauses is an anomaly within the law of contract which is generally based upon the concept of freedom of contract and where the courts are not intent upon mending unfair bargains. Accordingly the courts are predisposed where possible to uphold contractual terms which fix the level of damages for breach. This predisposition is even stronger in the case of commercial contracts freely entered into between parties of comparable bargaining power. Fourthly, in all of the cases reviewed, only four resulted in the liquidated damages provisions being struck down as a penalty and in each case it was shown that there had been a very wide gulf between the level of damages likely to be suffered and the damages stipulated in the contract. Taking these observations into account, and based upon the facts of the case, Justice Jackson concluded that the £45,000 per week liquidated damages entered into the building contract was an entirely reasonable pre-estimate of damages which could not be categorised as a penalty. The development funding agreement was worded in such a way that Tilebox would be liable to Standard Life to secure completion by the date required under the building contract. Accordingly at the time of entering into the building contract it was foreseeable that Tilebox would suffer losses flowing from delay. These would comprise its own direct losses, including any reduction in the development completion payment which Tilebox would receive from Standard Life, and any residual liability in damages to Standard Life. On a fairly broad brush calculation, taking these potential losses together, a loss considerably in excess of £45,000 per week might have been envisaged. The fact that it was likely that the development completion payment due to Tilebox would have eroded to nothing over the period of delay did not contradict this conclusion. At the time of negotiating the contract both parties took the view that if there was delay, it would be for substantially less than the period over which the development completion payment would be due. Against this background it was perfectly sensible and reasonable for the parties to agree a weekly figure which incorporated allowance for erosion of the development completion payment.
CJ-0524
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