Tuesday, June 21, 2005

Construction Claim & Dispute Resolution-3

Chapter 3: Liquidated And Ascertained Damages (LAD)

Construction contracts do usually provide for “Liquidated Damages” in an event of a delay by the contractor. The aim of liquidated damages is to provide for a negotiated and fair method of allowing for the possibility of a delay in completion of the project, which provides adequate compensation for the purchaser/owner, while ensuring that the contractor is not too heavily penalized for the delay. The term “liquidated” means that the measure or scale of such damages has been set down in the contract in agreed and mathematically quantifiable terms.

A great deal of confusion still exists as to what is the precise test to distinguish between genuine liquidated damages and the rule of law against penalty imposed in contract. This rule is that where a contract provides for damages to be paid by a party in breach of contract, the amount or scale of damages provided for must be such that it is intended reasonably to compensate the innocent party, and not to punish the party in breach. If the amount is excessive or punitive, then it is a “penalty”.

A penalty is null and void and of no effect to a contract. The true test of the legality of the liquidated damages is what the parties are presumed to have had in mind at the time of the making of the contract. At that time, we must ask whether or not the scale of liquidated damages was genuinely negotiated and agreed as an attempt to pre-estimate, in good faith, the likely loss to the owner. Courts generally do not enforce liquidated damages that are intended to serve as a penalty or are far in excess of the amount of damages the parties may reasonably forecast.

If the agreed sum, whatever is called in the contract, is a penalty it will not be enforced by the courts The onus of showing that the clause is a penalty clause lies upon the party who is sued upon it, and the court should not be astute to descry a “penalty clause”.

The classic form of penalty clause is one which provides that upon breach of a primary obligation under the contract a secondary obligation shall arise on the part of the party in breach which does not represent a genuine pre-estimate of say loss likely to be sustained by him as the result of the breach of primary obligation but is substantially in excess of the sum. "The essence of a penalty is a payment of money stipulated as in terrorem of the offending party; the essence of liquidated damages is a genuine covenanted pre-estimates of damages.” [Selva Kumar v Thiagarajah].

Under Clause 23.0 of the PAM form of contract 1998 (Extension of Time Clause), the architect is duty bound to grant extensions of time not later than practical completion so that the contractor will know his position before the final certificate and the contractor may be entitled to know the amount of extension in respect of any particular matter at the earliest possible moment [Sundra Rajoo, pg. 198, The Malaysian Std. Form Of Building Contract, PAM 1998 Form, 2nd. Edition, MLJ, 1999].

Before the certificate of non-completion is issued, the architect must perform his duties as regards adjudicating upon any outstanding applications for extensions of time under Clauses 23.0 and Clause 32.1(iii). Should the certificate of non-completion been issued and a subsequent cause of delay arises which entitles the contractor to a further time extension, a further certificate of non-completion under Clause 22.1 is required to be issued.

Loss and/or Expense

Given the nature of the construction process which uses costly equipment and highly paid staff arising from the project based employment, it is common for a contractor to suffer, or allege that he suffers, disturbance in the regular progress of the works due to causes within the employer’s or architect’s control. Loss and /or expense claim can usually arise from these reasons: -
  1. Direct loss & expense involved in variations
  2. Direct loss & expense caused by excusable delays (i.e. disturbance of regular progress of work)

In either case, the contractor has to make a written application within a reasonable time having incurred the loss and/or any part of the works have been affected or delayed as a result of the instruction. The broad purpose of the loss and/or expense clause provided in any contract is to reimburse the contractor for any loss and/or expense, which he has suffered or incurred as a direct result of certain specified events in the contract. Contractors can also made a claim under this clause if regular progress of the works or any part thereof has been “materially affected” by one or more of the stated events specified in the clause.



hojkay said...

The Malaysian Contracts Act 1950 makes no distinction between LAD and Penalty : see selva kumar a/l murugiah v. thiagarajah a/l retnasamy.

Therefore the defense of penalty clause is not applicable.

unaa_85 said...

is it LAD=penalty in malaysian construction industry?

Maverick SM said...

Hojkay & Unaa_85,

You are right that S.75 makes no distinction between LAD and Penalty and the Employer have to prove loss or it was a genuine pre-estimate.

Mazuan Lin said...

The first case which the court held that there is no distinction between lad and penalty is SS Maniam v Govt of Perak. It was quoted in Selvakumar I think.

Mazuan Lin said...
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Mazuan Lin said...
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