Liquidated damages represent a genuine pre-estimate of delay damages that may be suffered by the aggrieved party in case of project late completion. Such amount is commonly included in construction contracts and expressed as a rate of fixed sum per calendar day that shall be payable if the construction works remained incomplete by the agreed practical completion date. This arrangement offers parties upfront certainty of quantum of delay damages which in turn facilitates risk assessment. Additionally, this also relieves the aggrieved party from the burden of proving delay related losses. Liquidated damages are quite commonly used in construction projects and its application is primarily governed by the parties’ terms of agreement. This article examines and compares the application of liquidated damages under both the Public Sector Standard Conditions of Contract (PSSCOC) published in 2020 and Singapore Institute of Architects (SIA) Building Contract published in 2016. By way of background, this article is Part 9 of an article series that compares various key contract provisions between  SIA and PSSCOC.

As SIA and PSSCOC are commonly used in construction industry of Singapore, this examination and comparison provide readers with a general understanding of how treatment of liquidated damages may differ between public and private sector projects. The key difference in application of liquidated damages between SIA and PSSCOC stemmed from their unique and distinct certification regimes. As regards SIA form, a Delay Certificate needs to be issued by the Architect prior to the Employer’s recovery of liquidated damages from the contractor whereas there is no equivalent certificate under the PSSCOC. It follows that the Employer under PSSCOC is allowed to recover liquidated damages once it is established that the works have not been substantially completed by the original or extended practical completion date. Whilst some may dismiss such difference as merely an administrative formality, this cannot be any further from the truth. In fact there are quite significant reasons and implications behind these different certification approaches all of which will be examined further in the subsequent sections of this article. 

Apart from certification that may precede any recovery of liquidated damages, another interesting issue that is often overlooked during tender and procurement is whether the contractor continues to be liable for liquidated damages if its employment is terminated under the contract. In other words, is the Employer entitled to recover liquidated damages from the terminated contractor until such time the replacement contractor completes the project? Or should the recovery of liquidated damages cease at the point of termination? It appears that both the SIA and PSSCOC takes a similar approach in this regard by having express condition to affirm the Employer’s right to recover liquidated damages from the contractor in issue post termination. The express conditions are necessary because based on case precedents, such recovery would not have been permitted if the relevant conditions had been silent on this matter. So what could be the rationale behind such condition and how should a contractor carry out its risk assessment? These questions will be further elaborated as well in this article as part of the comparison between contract forms. 

Before one delves into the intricacies of application of liquidated damages set out above, it is equally important to appreciate the overarching commercial principles including how to calculate liquidated damages as well as types of liquidated damages. These basic concepts are important before any agreement to liquidated damages as the contractor is usually expected to acknowledge that the liquidated damages are reasonable and not intended to operate as penalty. Any party that does not adequately appreciate the basics of liquidated damages will often find it daunting if not impossible to effectively negotiate the relevant terms.

How To Calculate Liquidated Damages?

There are in general three methods of calculating liquidated damages namely (1) loss of income/ additional rental expenses during schedule overrun (2) extended consultancy and supervision charges and (3) additional financing costs of capital employed. Whilst none of these methods are mutually exclusive, it is customary that only one method is used in calculating liquidated damages to ensure that the ultimate sum derived in commercially acceptable. Standard conditions of contract do not typically dictate how should liquidated damages be calculated nor impose an obligation on the Employer and its consultants to divulge the formula to the contractor. It is also fairly uncommon for disputing parties to unravel the actual calculation of liquidated damages for the Employer to justify that the sum fixed is fair and reasonable to ensure its enforceability. By contrast, one of the principles established under the hallmark case of Dunlop Pneumatic Tyre Co Ltd v New Garage & Co Ltd states that even if the consequences of breach are such as to make precise pre-estimation almost an impossibility, it is no obstacle for the liquidated damages to represent a genuine pre-estimate of damage. In other words parties are free to bargain and agree on the sum of liquidated damages even if it is a mathematical challenge to be precise in pre-estimating the losses. The court is in no position to intervene if parties made a business decision as part of the function of free market. 

Given the above, it is incumbent upon the contractor to not squander perhaps the only opportunity during pre-contract to examine the proposed liquidated damages, ensuring that it is truly satisfied that the sum is fair, reasonable and proportionate. To this end, it is important to understand the basis of calculation of liquidated damages. Liquidated damages that are found to be a penalty may be rendered unenforceable. One of the classic definition of a liquidated damages that is found to be a penalty is when the sum stipulated is so extravagant and unconscionable in amount relative with the greatest loss that could conceivably be proved to have followed from the breach. This is once again one of the principles established under Dunlop Pneumatic Tyre Co Ltd v New Garage & Co Ltd. Therefore in examining the liquidated damages proposed during tender, an understanding of the underlying calculation may be instrumental in determining whether it has elements of being a penalty. Although both the SIA and PSSCOC do not dictate the ways to calculate liquidated damages, the latter form is commonly used for public sector construction works that are not necessarily revenue or income generating. The construction of public infrastructures e.g. flyovers, bridges, pedestrian paths, recreational parks, vehicular tunnels etc are of quite different nature than say private sector projects e.g. commercial buildings, condominiums. Therefore, there is no one size fit all approach when liquidated damages are calculated. 

In essence, the loss of income or additional rental expense approach is more suitable for private sector commercially driven projects. As with most pre-estimation, it is essentially a desktop exercise that includes various arithmetical assumptions. If the project involves construction of a grade A office building in downtown, there is an expected loss of income in the event of delay to project completion. Such income generally refers to rental income that is typically measured in dollar per square foot as it relates to rentable areas as opposed to gross floor areas. It should also be noted, that not all rentable areas are equal, where certain premium ground floor locations with high footfall with retail functions are likely to fetch premium rentals than other less prominent locations within the same building. Therefore if the commercial building is divided into multiple phase completions but ironically with uniform liquidated damages notwithstanding the likely difference in rentability, it is an indication that closer examination of calculations is warranted. On the other hand, if a residential development is completed late, it is not uncommon for liquidated damages to be projected based on damages suffered by prospective occupants or buyers that had to pay rentals for alternative accommodations. At the point when liquidated damages are calculated, one will be hard pressed to accurately estimate how many apartment units may be sold and therefore how many buyers may suffer such damages. Therefore it will be instructive to understand the assumptions used in calculation so as to determine whether the mathematical projection is outrageously extravagant.  

By contrast, the additional consultancy and supervision charges as well as extended financing costs of capital employed are calculations that can be made more accurately because most of these variables could be determined in advance e.g. interest rates, professional fees, extent of borrowings. These are charges already incurred by the Employer at the point when calculations are made. Computation of liquidated damages using these approaches tend to be more accurate but are relatively lower quantum than the other revenue or income driven approaches. 

Types of Liquidated Damages

Clause 25(1) of the SIA form and Clause 16.1(2) of the PSSCOC state that where the works are divided in phases, each phase shall have its own liquidated damages i.e. liquidated damages for phase of works. Where the project is not divided in phases, there shall only be one liquidated damages i.e. liquidated damages for overall works. Each phase of works, if implemented operates like a contract of its own with its own completion date, maintenance period or defects liability period as well as separate administration of extension of time. These separate and distinct mechanism allow the proper function of liquidated damages for phase of works. 

Just as the contract forms do not dictate how should liquidated damages be calculated, there is similarly no requirements imposed on the parties as to how the works should be divided in phases. It is however important to note that since each phase of works has its own liquidated damages, it follows that any delay to a designated phase of works should in principle give rise to delay damages. Where delay to any given phase of works does not in principle cause  damages, the enforcement of liquidated damages may be problematic. That observation should nudge one to reconsider whether it was appropriate to classify certain parts of works as a phase of its own. Whilst liquidated damages relieves the claiming party from the burden of proving its actual losses, it does not excuse that party from recovering losses that could not possibly have existed. Therefore in the conceptualisation of phases of works, these are important contractual considerations. By way of illustration, if a large commercial development is divided into phases, each phase is usually geographically separable and identifiable. It may be problematic if the access roads to such development is categorised a phase of works with its own phase completion date that is much earlier than any other phases of work. The enforceability of such phase liquidated damages could be in issue because even if the access roads are completed late but before the operation of the development, the Employer should not suffer any adverse financial consequences. If it could be objectively established that these roads are not required to be functional prior to the operations of the development, what could possibly justify the need for liquidated damages? Therefore having a proper logistic and operational understanding of the project is extremely crucial in stipulating an enforceable liquidated damages for phase of works.

Certification Process Prior To Recovery of Liquidated Damages

As alluded to earlier at the beginning of this article, one of the key differences between SIA form and PSSCOC relates to the certification process prior to recovery of liquidated damages. Under Clause 24(2)(a) of the SIA form the Employer shall only be entitled to recover liquidated damages from the contractor upon receipt of a Delay Certificate from the Architect. Such certificate shall include the following information: (i) original Completion Date, (ii) any duration of extension of time granted, (iii) any extended Completion Date, (iv) affirmation that the contractor is in culpable delay. As such certificate is not available under the PSSCOC, the Employer may commence recovering liquidated damages as soon as the works are not substantially completed within the stipulated time for completion or any extended thereof in accordance to Clause 16.1(1). Contrary to popular belief, whether or not works are substantially completed can sometimes be grey or subjective. ‘Substantial’ completion suggests that the works had to be ‘mostly’  or ‘significantly’ completed as opposed to ‘absolute and final’ completion. Although what constitute substantial completion is usually defined under the contract, interpreting such contractual definition involves judgment call by the certifier. Therefore in determining whether certain outstanding works are tolerable or acceptable, it is a question of whether such works may be deemed ‘minor’ and could be completed after issuance of practical completion certificate. 

To allow recovery of liquidated damages immediately if the works remain incomplete after practical completion date, could be risky because it may not be clear whether the contractor is entitled to any extension of time. The assessment of such time extensions can be time consuming as there are usually submission details that may influence the outcome of delay analysis. Therefore, if the Employer under PSSCOC commences recovery of liquidated damages unilaterally pursuant to Clause 16.1(1) without any supporting validation or certification from the Superintending Officer, there is clearly an element of risk.

The nature of the initial notification requirement under SIA form in respect of application for extension of time is less onerous than the PSSCOC. This could possibly explain why a Delay Certificate is required before recovery of liquidated damages. Under Clause 23(3) of the SIA form, the contractor is merely required to notify the Architect within 28 days of the occurrence of an event that he considers entitles him to extension of time, including reasons why there shall be delay to completion. The extent of information disclosure expected from the contractor is merely to enable to Architect to decide whether there is an in-principle entitlement to extension of time, rather than to enable to Architect to perform any delay analysis to decide the merit of its application. Therefore it is entirely possible that where the works remain incomplete after the original completion date, both parties are unclear what is the duration of time extension that the contractor is actually entitled to. This will prevent any fair and equitable recovery of liquidated damages. The implementation of Delay Certificate therefore provides a necessary and much needed point of clarity to the administration of extension of time. On the other hand, under Clause 14.3 of the PSSCOC, the notification requirement for extension of time by the contractor is relatively more extensive. The contractor is required to not merely state the delaying event but also why there may be delay, the length of delay, the duration for time extension required as well as the effects on the accepted baseline programme. By implication, when the works remain incomplete after completion date, the Superintending Officer should be in possession of the necessary details to not merely provide an in-principle determination of any entitlement to extension of time but also the actual time extension that could be granted.

Post Termination Liquidated Damages

When project completion is delayed so severely that the Employer terminates the contractor’s employment under the contract so as to engage a replacement contractor to complete the remaining works, can the liquidated damages clause survive such termination? In other words, will the terminated contractor be liable for liquidated damages after the point of termination? Under LW Infrastructure Pte Ltd v Lim Chin San Contractors Pte Ltd [2011] SGHC 163, the court affirmed the well established principle that no claim to liquidated damages can be brought in respect of the period after termination, unless there is express contractual provision. In this regard, SIA form and PSSCOC provide express conditions to allow the Employer to recover liquidated damages beyond the point of termination.  

Under Clause 32(8)(i)(i) of SIA form, which deals with effects of termination of the contractor’s employment, the Employer shall be entitled to the same liquidated damages for delay as those which shall have applied under the terms of the contract if the contractor shall have completed the works on the actual completion date of the replacement contractor. Similarly under Clause 31.3(a) of the PSSCOC which deals with liquidated damages after termination, the Employer shall be entitled to the same liquidated damages for delay as those which would have been payable if the contractor had completed the works on the actual completion date of the replacement contractor. 

In reality most contractors may find it difficult to accept that they shall continue to remain responsible for the construction duration of a project which had been taken out of their hands. Further, it is likely that the replacement contractor would be required under its separate contract to complete the project within a stipulated time for completion, failing which certain liquidated damages should apply. Therefore it is possible that the Employer may be able to have access to two separate sets of liquidated damages namely from the terminated contractor and the replacement contractor for the project in issue. 

In this regard, both the SIA form and PSSCOC included provisions to allow the terminated contractor to have certain relief from the full brunt of liquidated damages in case of delay caused by the replacement contractor. Under Clauses 32(8)(i)(ii) and 32(8)(i)(iv) of the SIA form as well as Clause 31.3(b) of the PSSCOC, the certifier shall in his assessment of delay take into consideration any failure by the replacement contractor to use due expedition and diligence in completing the remaining works as well as any credit for matters post termination that shall entitle the terminated contractor to any extension of time. Whether these provisions could be administered satisfactorily in reality remains to be seen particularly when the terminated contractor would have very limited access to any information on the progress of remaining works. Therefore, the terminated contractor should endeavour to maintain contact with any subcontractors that may continue to carry out works under the replacement contractor so as to gain access to information relating to any post termination activities. These particulars could be helpful for any future legal actions. 

Any objective determination of whether the replacement contractor had carry out the remaining works with reasonable diligence and expedition is dependent on how the completion date is established under its new agreement. If the replacement contractor successfully negotiated a more relaxed and favourable completion date, the likelihood of its culpable delay is reduced significantly. The Employer may not be averse to agreeing to a more relaxed completion date with the replacement contractor if the terminated contractor continues to be liable for liquidated damages for the period concerned. Even if the project is ultimately completed by the replacement contractor, it is extremely likely that the overall construction duration is significantly longer than what was originally planned. This is considering the fact that there are certain additional procurement and negotiation activities that had to be undertaken in consequence of the termination. Much of these additional activities can only be meaningfully carried out post termination. Therefore, the Employer may argue that there is nothing untoward as regards recovering liquidated damages from the terminated contractor for such additional time taken to complete the project.

Conclusion

Based on the issues discussed above, it appears that there are more similarities than differences as regards the application of liquidated damages under both the SIA form and PSSCOC. It is also evident that for one to have a comprehensive understanding of application of liquidated damages provisions, it may not be sufficient for one to only review the relevant clauses included in the contract forms. A great deal of the logistic, operational and financial considerations of the project ought to be considered in establishing a reasonable and enforceable liquidated damages sum. In this regard, liquidated damages is one of the unique features within a construction agreement where its application involves an equal blend of both commercial and contractual principles.




Koon Tak Hong Consulting Private Limited