Let’s start by going back to basics…what are liquidated damages?

Liquidated damages are a pre-agreed sum payable as compensation for loss arising from a breach of contract. In construction contracts, the best-known example is liquidated damages for failure to complete the works on time. The specified sum will usually be payable each day from when the works were required to be completed until the works are actually completed (or the contract is terminated/an agreed cap is reached).

Liquidated damages create a contractual right to the specified sum as compensation for the relevant breach. If drafted properly, they offer benefits to both parties:

  • the defaulting party has certainty of its liability for breach of the relevant obligation (traditionally, liquidated damages have been interpreted as an exclusive remedy meaning the defaulting party will not also be liable for general damages for the same breach); and
  • the innocent party is saved the time and cost of establishing its entitlement to general damages for breach of contract and quantifying its loss.

The penalties doctrine has long allowed contractors to contest the application of excessive liquidated damages. Based on the latest authority, liquidated damages may be unenforceable if they are out of all proportion to the legitimate interest of the party enforcing them.[1]

What happened in Cappello v Hammond & Simonds NSW Pty Ltd [2020] NSWSC 1021

In Cappello, the builder was engaged to renovate the ground floor of the plaintiffs’ residence under the standard form Housing Industry Association NSW Residential Building Contract for Works on a Cost Plus Basis.

Consistent with the default position under the HIA Contract, liquidated damages for late completion were set at $1 per day.

Ultimately, completion of the works was about 7 months late. Despite this, the builder made no applications for any extension of time. Among other things, the plaintiffs claimed general damages for delay.

The Builder cited a number of authorities to support its argument that by providing for liquidated damages the parties intended to exclude a right to general damages for delay.

Justice Ball acknowledged that general principle, but questioned whether by inserting a nominal amount for liquidated damages the parties intended to:

  1. exclude the operation of the liquidated damages clause; or
  2. exclude a right to claim damages for delay altogether.

Justice Ball considered that the proper construction of the contract was tied to the question of whether the liquidated damages clause was void under the Home Building Act 1989 (NSW). Section 18B(1)(d) implied a warranty into the contract that the work would be finalised within the stipulated time and section 18G rendered void any provision of the contract that purported to restrict or remove the plaintiffs’ rights in respect of that warranty.

Justice Ball held that a provision which limits a party to claiming nominal damages for a breach of a warranty restricts the rights of that person in respect of the warranty “since it substitutes for a substantial right for its breach a nominal one” and is void under s 18G.[2]

Since one of the two interpretations was void, Justice Ball preferred the other. He held that by not providing a substantial right to claim liquidated damages the parties instead left the plaintiffs a right to claim general damages (although based on the facts general damages were not ultimately awarded).

It must be noted that this conclusion was qualified, with Justice Ball emphasising that the outcome “may well be different if the clause had provided for the payment of a substantial amount by way of liquidated damages.” [3]

It is also worth noting that Justice Ball was influenced by the fact the contract was based on the HIA standard form “specifically drafted for use in relation to residential building work in New South Wales” and that $1 per day liquidated damages was the default position.[4]

He declined to infer that the drafters of the standard form contract intended to adopt a default position that rendered the provision relating to liquidated damages void.

The full judgement can be viewed here.

Implications and questions

The requirement for liquidated damages to be commensurate to the loss of the innocent party has traditionally been applied in the context of the doctrine of penalties to protect contractors from disproportionate liabilities.

Cappello now indicates that liquidated damages in contracts for residential building works must offer a “substantial right” to compensation for the innocent party (and if not, general damages will remain available). Since the liquidated damages, in this case, were patently nominal, Justice Ball was not required to propose a test for what will constitute a “substantial right” (including whether it must be proportionate to or a genuine pre-estimate of the loss that will actually be suffered by the innocent party). However, at a minimum, we know it must be more than nominal.

Justice Ball was also not required to consider whether an aggregate cap on a party’s liability for liquidated damages would be enforceable. However, the same principles may be applied –any cap on liquidated damages in a contract for residential building works under the Home Building Act must afford the owner a “substantial right” to compensation for the relevant breach.

Takeaway points

In light of Cappello, parties should be aware of the following in contracts to which the Home Building Act applies:

  • an attempt (even through express terms) to preclude the builder’s liability for delay or limit it to a nominal amount will be void;

  • if the parties wish to preclude general damages for delay, they should insert a rate of liquidated damages that offers the owner a “substantial right” for breach of the warranty that the work will be done within the time stipulated in the contract;

  • the default position under the Housing Industry Association NSW Residential Building Contract for Works on a Cost Plus Basis will be interpreted to mean the owner is entitled to nominal liquidated damages plus general damages; and

  • builders performing works under existing contracts based on the default HIA position should be aware of their potential liability for delay and diligently claim extensions of time.

For assistance on all building contract issues, please don’t hesitate to contact Morrissey Law + Advisory for assistance.

 


[1] Andrews v Australia New Zealand Banking Group Ltd [2012] HCA 30, (2012) 247 CLR 205 at [32]; Paciocco v Australia New Zealand Banking Group Ltd [2016] HCA 28, (2016) 258 CLR 525.

[2] Cappello v Hammond & Simonds NSW Pty Ltd [2020] NSWSC 1021 at [31] (our emphasis).

[3] Ibid at [32] (our emphasis).

[4] Ibid at [30].


 

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