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When is a penalty not a penalty? Commercial Court consolidates the law in GPP v Solar

06.02.2019 Energy & infrastructure

Simon Hems

Simon Hems Head of Energy & Infrastructure, Partner

The judgment in Cavendish Square Holding BV v El Makdessi and Parking Eye Ltd v Beavis [2015] UKSC 67 gave English law an updated, modern approach to the question of penalties and liquidated damages. Since then, there have been very few cases in which guidance on how Makdessi should be applied has been given. The recent decision in GPP Big Field LLP, GPP Langstone LLP v Solar EPC Solutions SL (formerly known as Prosolia Siglio XXI) [2018] EWHC 2866 (Comm), in which the High Court has had the opportunity to apply the current law to a fairly standard liquidated damages provision in a construction contract, is therefore very welcome.

GPP v Solar concerned a series of five engineering, procurement and construction (EPC) contracts for the construction of solar power generation plants in the UK: one near Salisbury; one near Cambridge; one in Somerset; and two in Devon.

The case involved claims for liquidated damages arising out of the late, or non-, completion of the works. The claims were brought against the parent company of the insolvent contractor in its capacity as guarantor/indemnifier of the contractor. The defendant was also pursuing counterclaims in respect of unpaid amounts that were due to the contractor under the EPC agreements.

Among the numerous issues that arose during the course of the matter, a fundamental challenge raised by the defendant was as to the legitimacy of the liquidated damages provisions, contained in the following article:

“In the event of the delay of more than fifteen (15) calendar days for the date of the commissioning, the Contractor shall pay to the [first claimant] a penalty, which shall be paid in the way that the amount of the penalty, as accrued up to the date of the next invoice of the Contractor to the [first claimant], shall be deducted from said invoice.  The amount of the penalty is hereby established as the amount of £500 per day per MWp installed and per day that the construction works suffer a delay (Delay Damages).  Delays of fifteen (15) calendar days or less shall not generate any penalty, being the 15 calendar days understood as an integral grace period over the whole Calendar of Works, not for each event of fortuitous reasons or Event of Force Majeure.  The maximum of the penalty for delays of the Works shall be two hundred and fifty thousand pounds sterling per MWp (£250,000/MWp).”

It was said by the defendant that this amounted to an unenforceable penalty because:

>  The language of the article expressly referred - several times - to the amounts that would fall due as a “penalty”.

>  The extent of the loss suffered would be dependent upon the output of the particular installation and the prevailing electricity price. A generic, flat amount included in each of the five EPC contracts could not, therefore, amount to a genuine pre-estimate of the loss likely to be suffered. This was compounded, the defendant asserted, by in excess of a 30 per cent difference in the electricity price recorded across the five EPC contracts.

The court disagreed.

Richard Salter QC, sitting as a Deputy Judge of the High Court, first pulled together the various legal strings that need to be addressed:

>  The question of whether a provision is actually a penalty falls to be considered as a matter of construction at the time that the provision was agreed.

>  The provision in question must be a secondary obligation.

>  Consideration must be given to whether a legitimate business interest is served and protected by the clause.

>  To be a penalty, the detriment imposed on the contract breaker must be extravagant, exorbitant and unconscionable compared to the legitimate interest of the innocent party.

In this matter it was common ground that the liability to pay liquidated damages was a secondary obligation, consequential to a breach of the primary obligation to complete the construction and commissioning by the contractual deadline.

In reaching the conclusion that the provisions in this contract were not a penalty – despite being described in the clause as exactly that – the judge agreed with the following points made in defence of the contractor’s argument:

>  Damages for delay provisions such as these are common in construction contracts.

>  The parties were experienced and sophisticated commercial entities of equal bargaining power, able to assess the commercial implications of their agreement.

>  Actual loss of revenue from the type of plant in question could well have exceeded the measure written into the contract.

>  According to the contract timetable, delay damages were intended only to kick in during the peak generation period for solar power installations.

>  The amount included in the contract was not extravagant or exorbitant.

>  There was a legitimate business interest in ensuring the plant was completed and operational on time.

It is reassuring that simply using the label of “penalty” will not be fatal to your contractual agreement. But of greater importance, perhaps, is the message this judgment sends that liquidated damages provisions are alive and well and will continue to be enforced in the context of what makes sense for business.

That said, there is a further point to note where this judgment bucks the previously accepted view that liquidated damages do not continue to accrue after termination of a contract. In this instance, considering this point, Richard Salter QC relied upon the judgment in Hall v Van Den Heiden (No 2) [2010] EWHC 586 (TCC), in which the court took the view that to allow a contractor to escape its liquidated damages obligations as a result of termination would be tantamount to allowing a contractor to benefit from its original default. The point is worthy of closer examination in terms of how widely applicable it may be and so is one we shall return to in a future update.

Article authors:

Simon Hems