Liquidated Damages - Unaoil Ltd v Leighton Offshore Pte Ltd 2014 EWHC 2965 (Comm)
Liquidated Damages – Unaoil Ltd v Leighton Offshore Pte Ltd  EWHC 2965 (Comm)
Often contracts are amended prior to or during performance. If they contain a liquidated damages clause, this should not be overlooked.
Many industry contracts contain a liquidated damages clause, a pre-agreed sum payable to one party for a specific breach of contract by another party. These commonly address contractor delay and/or defective performance. Key advantages of such clauses are that they offer both parties certainty over the damages payable for delay, and provide scope to limit a contractor’s liability.
The recent case of Unaoil Ltd v Leighton Offshore Pte Ltd  EWHC 2965 (Comm) serves to illustrate that where a contract is amended to reflect a lower price, if the liquidated damages clause remains unchanged, there is a risk of the liquidated damages provision becoming unenforceable as a penalty.
The case concerned Leighton Offshore Pte Ltd (Leighton) tendering for engineering and construction work on an oil pipeline project in Iraq. A memorandum of agreement (MOA) was drawn up under English law between Leighton and Unaoil Ltd (Unaoil) and executed in December 2010, envisaging Unaoil performing work on the project.
The MOA provided for an agreed price of US$75m and clause 8.1 stated:
“If LEIGHTON OFFSHORE is awarded the contract for the PROJECT by the CLIENT, and LEIGHTON OFFSHORE does not subsequently adhere to the terms of this MOA and is accordingly in breach hereof, LEIGHTON OFFSHORE shall pay to UNAOIL liquidated damages in the total amount of US$40 million. After careful consideration by the Parties, the Parties agree such amount is proportionate in all respects and is a genuine pre-estimate of the loss that UNAOIL would incur as a result of LEIGHTON OFFSHORE’s failure to honour the terms of the MOA.”
The MOA also provided for a non-refundable advance payment to Unaoil of 15% of the contract price, as well as a “Non Refundable Pipe Laying Equipment Asset Write Down And Mobilisation Payment of 7.5%” of the contract price.
Amendment to the MOA
The MOA was amended in March and again in April 2011, with the main difference being a reduction in the contract price to US$55m. As part of the amendment, Unaoil would also be paid a marketing fee of 5% on any amount Leighton received on the project above US$500m, set at a minimum of US$25m.
Leighton’s tender was successful, but Leighton then chose not to formally sub-contract with Unaoil. Unaoil continued to prepare for the project and submitted an invoice for advance payments which Leighton failed to pay.
In Commercial Court proceedings Unaoil claimed the following: the specified advance payments as a simple debt claim; damages for loss of profit resulting from Leighton’s repudiatory breach; and liquidated damages of US$40m.
The court rejected all of Leighton’s defences as to the debt claim and awarded Unaoil US$12,577,500, as the two advance payments due under the contract. The loss of profit claim however failed. Although Leighton had breached the contract by deciding not to sub-contract with Unaoil, such that Unaoil was entitled to damages, this was only to the extent that the loss of profit exceeded the advance payment. The court had difficulty in quantifying the precise loss of profit, and concluded it to be in the region of US$5.8m, despite Unaoil claiming US$25m for support services which Leighton had never used. The precise value was of less importance however, for because the sum was noticeably less than the value of the debt claim, it had already been covered by the advance payments.
As for the liquidated damages claim, the court ruled that the sum stated in the MOA (US$40m) was an unenforceable penalty, and referred to Talal El Makdessi v Cavendish Square Holdings BV and another  EWCA Civ 1539. The applicable principles for determining whether a liquidated damages clause will be unenforceable as a penalty were discussed in El Makdessi and the case demonstrates a recent shift in the approach of the courts. Traditionally, a primary consideration was whether the liquidated damages were “extravagant and unconscionable” in comparison with the greatest conceivable loss such that the effect was one of deterrence of breach (Dunlop Pneumatic Tyre Co Ltd v New Garage & Motor Co Ltd  UKHL 1). El Makdessi concerned a Share Purchase Agreement which provided for liquidated damages on the seller’s breach. Whilst the court ruled that the particular provision had been agreed by commercial equals on a level playing field, and that the damages were extravagant, unreasonable, lacked commercial justification and fell into the category of deterrence, such that they were unenforceable, the court suggested that the term “unconscionable” might nowadays be more appropriately applied to a clause which provides for extravagant payment without commercial justification.
Whilst the court in Unaoil found that the liquidated damages may have represented a genuine pre-estimate of the loss when the MOA was signed, it held that where a contract has been amended in a material respect, the relevant date was the date at which the MOA was amended. This approach appears logical, considering that there could be numerous potential changes to a contract which could render an earlier liquidated damages sum no longer commercially justified.
The court considered that, following the reduction of the contract price from US$75m to US$55m, the original liquidated damages amount of US$40m could no longer be seen as commercially justified. In its view and in the absence of clarity as to why the liquidated damages clause was not considered at the same time as the amendments, it was highly unlikely that both parties would have agreed to the original liquidated damages in the context of the amendments.
What does this mean for contractors?
The situation of Unaoil is quite different from usual examples of liquidated damages, as the clause in question was intended to compensate the subcontractor for the contractor’s breach, whereas the more common use is to compensate an employer company for a contractor’s delay.
This case however highlights the importance of checking whether amendments to a contract impact on other provisions and particularly whether an existing liquidated damages sum may fall into the category of a penalty. If the liquidated damages sum is not amended, and absent commercial justification for the sums identified, a court may be inclined to hold the provision unenforceable as a penalty. This is especially relevant in engineering contracts which may undergo significant changes throughout the duration of the contract, whether increasing or decreasing the price of the contract and/or the scope of work to be performed.