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Adjustment of liquidated damages: freedom to contract v unfair windfall

In this first of a three-part blog series we consider some key contractual issues in the context of the Qatari and UAE construction market. We begin with an overview of liquidated damages (LDs) provisions for project delays.

We all know that an employer’s entitlement to liquidated damages has a significant impact on contractors and the supply chain. If the contractor misses a contract milestone, most contracts in Qatar and the UAE allow employers to levy liquidated damages.

Liquidated damages permitted

Liquidated damages are permissible under both the UAE and Qatari Civil Codes.  As elsewhere in the world, the liquidated damages clause fixes a sum within a contract that is due on the occurrence of delay to an event or milestone.  The often-stated purpose of the clause is to provide certainty of risk at the contract negotiation stage in relation to time and remedies for delay. However, the reality is that liquidated damages primarily benefit an employer, given that such a clause removes the burden on the employer to prove damages suffered as a result of delays.

The common law distinguishes between a delay penalty provision, which is penal in nature and therefore prohibited, and a liquidated damages provision, which must be a “genuine pre-estimate of loss”.  However, in recent years, the English courts have moved away from this dichotomy and are more reluctant to find that a clause is penal. The “commercial justification” of the clause is the current broad approach: is the provision extravagant or oppressive and is its predominant purpose to deter breach? In contrast, in the UAE and Qatar, the distinction between a delay penalty and a liquidated damages provision does not have the same significance.

A different approach

The literal translation of “liquidated damages” in Arabic is “fines”. Both the UAE and Qatari Civil Codes allow parties to agree any level of future liquidated damages (or “fines”), notwithstanding the figure may be arbitrary or excessive.  This reflects both jurisdictions’ primary principle of freedom to contract. However, in both jurisdictions, this is subject to the discretion of the courts (and arbitrators applying the Civil Code). They may adjust the amount of liquidated damages to reflect the harm actually suffered, in order to prevent one party obtaining an unjustified windfall.

In common law jurisdictions, the enforceability of the clause is judged by reference to what was known at the date the contract was entered into. The actual loss suffered as a result of a delay is, strictly speaking, immaterial in common law jurisdictions. The position in the UAE and Qatar is therefore fundamentally different to the common law approach.

Assessing damages

There is also divergence between the UAE and Qatari Civil Codes in the assessment of liquidated damages.

In the UAE, Article 390(1) of the Civil Code allows the parties to agree a fixed amount of damages in advance. Article 390(2) allows the court, upon petition, to decrease or (importantly) increase the amount of damages to reflect the actual loss suffered. This discretion to increase the level of damages presents a serious risk for a contractor starting legal action.

In the context of the Code’s emphasis on sanctity of contracts, our experience is that the UAE Courts require robust evidence to demonstrate there is a disparity between the actual loss suffered and the level of contractual compensation. Reduction of delay damages was at issue in the UAE Federal Supreme Court case 103 of 2004. The court ruled that the contractually stipulated rate of liquidated damages was overestimated compared to the damage suffered by the party imposing liquidated damages and therefore should be reduced.

In contrast to the UAE, the Qatari Civil Code does not allow a court to revise the rate of liquidated damages upwards, except in the case of fraud. They may only maintain or adjust the level of damages downwards, reducing the risk that an application may result in a higher level of damages.

For an application for a downward adjustment of liquidated damages to succeed in Qatar, the Civil Code provides that the Contractor must demonstrate that the pre-estimate of damages was “grossly excessive” to the harm actually suffered or that no loss was suffered at all. By contrast, according to the equivalent provision of the UAE Civil Code, the court may adjust the agreed amount of compensation “under any circumstances”, so that it is equal to actual loss. 

Qatar and extensions of time

It is not all good news for contractors in Qatar. They should be aware that the Qatari Civil Code entitles an employer  to impose an additional penalty of up to 10% of the contract price in the event that an extension of time is granted to the contractor (see Article 56 of Law No. 26 of 2005).

At least in Qatar, in contrast to the UAE, the parties have the assurance that the damages will not be increased by the court to reflect the actual loss suffered. However, pursuant to Article 56, contractors ought to beware of applications for extensions of time.  While the central tenant of sanctity of contract remains in respect of liquidated damages, in reality the discretion of the court in Qatar and, more particularly, in the UAE, may lead to uncertainty as to recovery.

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