The recent Azimut-Benetti decision last year is the latest in a long line of decisions in which the courts have addressed the important question of whether a liquidated damages clause (LDC) is enforceable or is in fact a penalty clause and not enforceable. The decision in Azimut - Benetti has ‘shifted the goalposts’ to a position where a party seeking to enforce an LDC can more confidently argue that it is a binding LDC provided certain conditions are satisfied.
What Are LDCs?
LDCs can be described as a contractual term which two parties have agreed upon which states that the injured party can recover (upon a specific breach by the offending party) a specified sum of money. Put in a construction context, this specific breach is late completion of a construction project. The sum articulated in the LDC is often expressed as an amount per day or per week.
Such clauses will not be considered enforceable by the courts if it is determined that its purpose is to punish rather than to compensate the injured party, i.e. it is a penalty.
The Current Law
Although not a construction case, the Azimut-Benetti v Healey decision will have an effect across the construction industry, given its impact and shift in approach towards how the courts will now analyse LDCs.
Briefly, the facts of this case concerned Azimut-Benetti (a luxury yacht builder in Italy) entering into a contract with a company owned by Mr Darrell Marcus Healey to construct a yacht for €38m. The relevant LDC provided:
“Upon lawful termination of this Contract by the Builder it will be entitled to retain out of the payments made by the Buyer and/or recover from the Buyer an amount equal to 20% of the Contract Price by way of liquidated damages as compensation for its estimated losses (including agreed loss of profit) and subject to that retention the builder will promptly return the balance of sums received from the Buyer together with the Buyer’s Supplies if not yet installed in the Yacht.”
When the Defendant’s company failed to pay the first agreed 10% instalment, the Claimant terminated the contract and proceeded to make a summary judgment action to claim 20% of the contract price under the LDC. Meanwhile, the Defendant argued the LDC was unenforceable as a penalty.
Decision
In deciding the case, Blair J departed from previous case law by moving towards a “commercial justification” test; namely that a LDC “may be commercially justifiable provided that its dominant purpose is not to deter the other party from breach”. Blair J held this was the case in this instance- the purpose of the clause was evidently to strike a balance between the interests of both parties should the Claimant lawfully terminate the contract (this was evidenced through the fact that the clause also made provision for the offending party to receive the balance of any sums already paid to the injured party as well as any supplies not yet used in the construction of the yacht).
Significantly, Mr Justice Blair set out:-
• Because the LDC had a clear commercial and compensatory justification for both parties, it was not a penalty and was therefore enforceable.
• Where both contracting parties are legally represented and have freely entered the contract, the court should (as much as possible) uphold the agreed contractual terms.
The Pre- Azimut-Benetti Interpretation Framework
In the Alfred McAlpine Capital Projects Ltd v Tilebox Ltd [2005] case, the LDC made the provision “Alfred McAlpine should pay liquidated and ascertained damages for delay at the rate at the rate of £45,000 per week or part thereof”. Sometime after the contract had been entered, it became clear that completion of the works would not take place until June 2005 (some two and a half years later than the anticipated completion date expressed in the contract - 14 August 2002).
This meant the LDC came into play- McAlpine was seriously concerned regarding its liability under the clause and proceeded to run the argument in court that the LDC was excessive and so amounted to an unenforceable penalty clause. Tilebox (as expected) opposed this.
In deciding that the LDC was not a penalty clause, Jackson MJ clarified the position the courts would now take in distinguishing between a valid LDC and a penalty clause-
• As had traditionally been required, the sum stated in the LDC must be a genuine pre-estimate of the likely loss to be suffered by the aggrieved party.
• For an agreed pre-estimate to be termed unreasonable (for it not to be a genuine pre-estimate) there must be “a substantial discrepancy between the level of damages stipulated in the contract and the level of damages...likely to be suffered”.
• The “genuine” pre-estimate test does not turn on the genuineness or honesty of the party making the estimate, although the court can take account of the thought processes of both parties at the time of contracting and agreeing to the LDC.
Earlier Cases and the Approach of the Courts
• Lord Dunedin in Commissioner of Public Works v Hills [1906] (on what constitutes a penalty clause)- whether the sum (of liquidated damages) stipulated for can...be regarded as a ‘genuine pre-estimate’ of the creditor’s probable or possible interest in the due performance of the principal obligation”. In the case it was held that the LDC was not a genuine pre-estimate as the sum stipulated had the propensity to increase with no relation to the actual cost of the damage to the injured party.
Lord Dunedin in Dunlop Pneumatic Tyre Co Ltd v New Garage Co Ltd [1915] (on the factors the court will look at in determining whether a LDC is in fact a penalty clause)-
• Regardless of the label of the clause, it is for the court to analyse the substance of the clause and its wording, to be judged as at the time the contract was made.
• An LDC in the true sense is a “genuine pre-estimate of damage” whereas a penalty clause is a payment of money as stipulated made by the offending party “in fear”.
• Was there unequal bargaining power between the parties at the time of contracting, such that one party was effectively dictating terms? If so, the clause is likely to be a penalty.
• The clause is a penalty where “the sum stipulated is extravagant and unconscionable in amount in comparison with the greatest loss that could conceivably be proved to have followed from the breach” and also where the same amount is payable under the clause, regardless of the nature or seriousness of the breach.
• “It is no obstacle to the sum stipulated being a genuine pre-estimate...if the consequences of the breach are such as to make precise pre-estimation almost an impossibility”.
What is a “Genuine Pre-Estimate of Loss”?
• Dunlop- The court will look at the likely damages in the ordinary course of events, not the conceivable damages. Key question- are the agreed liquidated damages an estimate of the likely loss to the injured party arising from the breach or is the amount a deterrent?
• Tilebox- Honesty and accuracy are not associated with whether a stipulated amount can be considered a “genuine” pre-estimate of loss.
Two Examples:-
Campbell Discount Co Ltd v Bridge [1962]- An LDC held to be a penalty clause because the clause provided a sliding scale which operated in the wrong direction- i.e. the less the depreciation in the value of the vehicle, the greater the compensation that the offending party had to pay- the clause clearly acted as a deterrent.
Philips v The Attorney General of Hong Kong [1993]- An LDC within a construction contract was held to be enforceable because it represented a genuine pre-estimate of the probable loss, which had been formed at the time of contracting. This outweighed the fact that the injured party could receive an amount in excess of its actual loss as a result of the clause (which can give the impression that the clause is penal in nature).
Two Examples of an LDC:-
“If the contractor shall fail to complete by the date stipulated in the contract (or any extended date), he shall pay or allow the employer to deduct liquidated damages at the rate of £1000 per day for the period during which the works are uncompleted.”
“The sub-contractor shall pay liquidated damages of £10,000 per day, or any sum imposed on the Main Contractor, whichever sum is greater, for delay in the sub-contract works or any loss or damages incurred by the Main Contractor.”
The first LDC is fairly standard in its wording (being present in many construction contracts). Lurking beneath these LDCs though are real issues as to whether such clauses would stand up to court scrutiny or whether they would be dumped in the “penalty” bin (to the horror of the party attempting to rely on it).
The Azimut-Benetti decision potentially widens the scope and enforceability of LDCs- as long as the stipulated amount is “commercially justifiable” and not intended to be a deterrent it is likely to be classed as an enforceable clause by the courts. This is likely to be the case even if a discrepancy remains between the amount payable under the clause and the amount of actual loss suffered by the injured party because we are now in a position whereby the courts are loathe to interfere where two commercially experienced parties have agreed to a LDC because of the uncertainty this would create.
Conclusion
The decision in Azimut - Benetti demonstrates that the courts are increasingly adopting a flexible approach towards the interpretation of LDCs and it may be commented with some degree of certainty that whilst the first of the above clauses would be regarded as a typical LDC, it is now arguable that the second clause (which would not have survived the previous approach of the courts) may also be classed as enforceable so long as it was negotiated freely and was deemed “commercially justifiable”.
Therefore, parties would now be advised to incorporate some justification for the LDC and also to calculate the sum in the LDC by reference to a genuine pre-estimate of loss for a particular breach. If possible, workings and/or a record of negotiations as to how the figure was arrived at should also be retained in the event that the LDC is challenged.
This article contains general advice and comments only and therefore specific legal advice should be taken before reliance is placed upon it in any particular circumstances.
Thursday, 24 February 2011
Agency Workers Regulations 2010
October 2011 is going to be a time of change in the workforce. The rules on agency workers are going to alter quite significantly, as the full effect of the Agency Workers Directive comes into force. These new laws will cover anyone who falls under the definition of an Agency Worker, which is anyone who is 'an individual who is supplied by a temporary work agency to work temporarily for and under the direction of a hirer.' Any organisations which contract directly with the worker, so that there is no agency introduction or administration involved, are not covered by these Regulations. There are estimated to be 1.3 million workers in the country who are employed through an agency, so the changes that these Regulations are going to have on the workforce cannot be underestimated.
The Regulations are designed to protect situations where agency workers are the second class in the workforce. Up until now, it has been fine for an agency worker's pay – normally at an hourly rate – to be less than the pay received by permanent workers doing the exact same job. This has led to situations where agency staff work longer and harder than permanent staff, but for less pay. Agency staff, by virtue of their employment status, have the least rights. They are therefore the least likely to complain, and in turn, are the workers who are the most likely to be exploited. In hard economic times, such exploitation is inevitably more pronounced, with companies needing to cut costs wherever possible.
The Regulations state that from when they come into effect, the agency worker's pay received will have to be the same rate as that received by permanent staff. Agency workers will also be entitled to all of the basic working and employment conditions as if they had been employed directly. This will include the lengths of their shifts, the right to take holidays, the right to have rest breaks, and equal treatment concerning shifts of unsociable hours.
This does not mean that they are entirely equal to permanent employees. The rights do not extend to occupational sick pay, pension entitlements, maternity or paternity leave, share options or profit share schemes. Furthermore, the agency worker does not at any point gain the right not to be unfairly dismissed, or the right to a redundancy pay.
To determine their rights, the agency worker would have to find an actual permanent worker of the hirer, who is doing a comparable role to their own. In other discrimination cases, for example relating to disability or gender, a worker can rely on a hypothetical comparator to prove that they are being treated worse than a colleague. To prove a case, an agency worker would need a real colleague who is doing the same job as them, but being treated better, to compare themselves to.
An agency worker also has another hurdle to overcome in proving a case. They would have to be working for the hirer for 12 weeks. This was a clause which the government, the CBI and the TUC agreed as a suitable opt-out which allows industry to have some flexibility. This means that workers on a contract shorter than 12 weeks can be paid less than workers of the hirer, even if they are doing the exact same role.
The business industry is clearly worried about the financial implications of this. To fill temporary roles, they not only have to pay the agency fees, but they have to pay the worker the exact same hourly pay as their permanent members of staff. This means that the agency worker, on the face of it, can cost the business more than the permanent member of staff. It is worth remembering, however, that the agency worker does not get paid when they are on leave or off sick, and they don't have any pension that needs contributing to. Furthermore, the business can quickly dispose of them when they are surplus to requirements, without having to follow any cumbersome procedures. A business can take comfort in the fact that when they take on agency workers, the end result is very unlikely to result in litigation when things go wrong. This comfort, of course, will now come at a higher price.
Businesses often complain that the employment laws are stacked against employers, and in the recession that we are currently in, these new Regulations will no doubt appear as another blow to managers trying to keep their workforce in employment in the first place. For those who champion workers' rights, however, these Regulations have been eagerly anticipated, and are long overdue.
The content of this article does not constitute legal advice and should not be relied on as such. Specific advice should be sought about your specific circumstances.
This article contains general advice and comments only and therefore specific legal advice should be taken before reliance is placed upon it in any particular circumstances.
The Regulations are designed to protect situations where agency workers are the second class in the workforce. Up until now, it has been fine for an agency worker's pay – normally at an hourly rate – to be less than the pay received by permanent workers doing the exact same job. This has led to situations where agency staff work longer and harder than permanent staff, but for less pay. Agency staff, by virtue of their employment status, have the least rights. They are therefore the least likely to complain, and in turn, are the workers who are the most likely to be exploited. In hard economic times, such exploitation is inevitably more pronounced, with companies needing to cut costs wherever possible.
The Regulations state that from when they come into effect, the agency worker's pay received will have to be the same rate as that received by permanent staff. Agency workers will also be entitled to all of the basic working and employment conditions as if they had been employed directly. This will include the lengths of their shifts, the right to take holidays, the right to have rest breaks, and equal treatment concerning shifts of unsociable hours.
This does not mean that they are entirely equal to permanent employees. The rights do not extend to occupational sick pay, pension entitlements, maternity or paternity leave, share options or profit share schemes. Furthermore, the agency worker does not at any point gain the right not to be unfairly dismissed, or the right to a redundancy pay.
To determine their rights, the agency worker would have to find an actual permanent worker of the hirer, who is doing a comparable role to their own. In other discrimination cases, for example relating to disability or gender, a worker can rely on a hypothetical comparator to prove that they are being treated worse than a colleague. To prove a case, an agency worker would need a real colleague who is doing the same job as them, but being treated better, to compare themselves to.
An agency worker also has another hurdle to overcome in proving a case. They would have to be working for the hirer for 12 weeks. This was a clause which the government, the CBI and the TUC agreed as a suitable opt-out which allows industry to have some flexibility. This means that workers on a contract shorter than 12 weeks can be paid less than workers of the hirer, even if they are doing the exact same role.
The business industry is clearly worried about the financial implications of this. To fill temporary roles, they not only have to pay the agency fees, but they have to pay the worker the exact same hourly pay as their permanent members of staff. This means that the agency worker, on the face of it, can cost the business more than the permanent member of staff. It is worth remembering, however, that the agency worker does not get paid when they are on leave or off sick, and they don't have any pension that needs contributing to. Furthermore, the business can quickly dispose of them when they are surplus to requirements, without having to follow any cumbersome procedures. A business can take comfort in the fact that when they take on agency workers, the end result is very unlikely to result in litigation when things go wrong. This comfort, of course, will now come at a higher price.
Businesses often complain that the employment laws are stacked against employers, and in the recession that we are currently in, these new Regulations will no doubt appear as another blow to managers trying to keep their workforce in employment in the first place. For those who champion workers' rights, however, these Regulations have been eagerly anticipated, and are long overdue.
The content of this article does not constitute legal advice and should not be relied on as such. Specific advice should be sought about your specific circumstances.
This article contains general advice and comments only and therefore specific legal advice should be taken before reliance is placed upon it in any particular circumstances.
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