Construction Claims Article Series – Damages claims

Introduction

This is our 6^th and final article in our construction claims series, which aims to provide practical legal insights for both contractors and principals. Topics covered over the last 5 weeks in the series, including variation claims, delay claims, price acceleration claims, site condition claims, and progress claims.

This week we discuss claims for contractual damages, including the types of damages which can be claimed in the construction context, legal principles for calculating and proving damages, and strategic considerations when facing a potential claim for damages.

What are ‘Damages’

‘Damages’ is the legal description for monetary compensation which can be awarded by a Court for losses suffered by a wronged party. When a contract is breached, the wronged party has a right to claim damages against the party who breached the contract.

The primary category of contractual damages is compensatory damages. To obtain compensatory damages a plaintiff needs to prove that they have suffered a loss which was caused by the defendant’s breach of contract, and which can be suitably compensated by an award of money. This broad category includes losses arising in a number of ways:

Expectation losses can be awarded to compensate a plaintiff for money which it would have reasonably expected to receive if the contract had been properly performed by the defendant. This ordinarily includes lost profits, or the value of goods or services promised but not delivered. In some circumstances, expectation damages can also extend to loss of a future opportunity for profit where that opportunity was sufficiently crystallised, probable, and the loss of it was closely connected to the breach of contract.
Reliance losses can be awarded to compensate a plaintiff for financial losses which it incurred in reliance on the defendant’s proper performance of the contract.
Indemnity losses can be awarded to compensate a plaintiff for money it is required to pay under an indemnity to a third party, for which the indemnified loss arose from the defendant’s breach of the contract between the defendant and plaintiff.

Where no financially compensable loss can be proven, the Court may instead award nominal damages, which is small token sum to acknowledge that a legal right was violated.

At all times, the overarching test for calculating damages arising from a breach of contract is to place the wronged party in the financial position they would have been in if the contract had been duly performed according to its terms. This test often results in a greater cost to the party in breach than what it would have cost them to properly perform the contract however, contractual damages are not inherently intended to punish the defendant.

Importantly, a Court will not award damages in a sum that would put a plaintiff in a better financial position than they would have been in, had the contract been duly performed. In practice, this means that even if a number of the above categories of losses arise in a particular dispute, the total amount claimable will always be subject to and adjusted in line with the overarching test.

Causation

To receive compensatory damages the plaintiff must be able to prove that the loss claimed was caused by the defendant’s breach. This is conceptualised by the “but for” test, which requires the plaintiff to prove that their loss would not have occurred “but for” the defendant’s breach.

The most obvious form of causation is direct causation. As the name suggests, this is where there the conduct or omission which was the breach of contract directly or ‘naturally’ caused the loss suffered by the other party.

In contrast, indirect causation is where the loss was suffered more broadly because of the breach. To limit how far this indirect liability extends, losses caused indirectly (also called consequential loss) can only be recovered if such losses were reasonably foreseeable by the parties as a probable result of the breach at the time the contract was made. This is referred to as a test of remoteness. Contracts will often have express terms further seeking to define, limit or exclude consequential losses which can be claimed for a breach under the contract.

Duty to mitigate

After a breach of contract occurs, the wronged party is required to take reasonable steps to mitigate their loss. If they fail to do so, they will lose their entitlement to any portion of their loss which they could have reasonably avoided. A plaintiff is however entitled to recover from the defendant any reasonable costs of mitigation. The test for what is “reasonable” to mitigate a contractual breach is what the party would otherwise do supposing they were unable to recover any damages. In previous cases, the Court has ruled plaintiffs to be acting unreasonably where they have:

failed to seek another contractor in a timely manner to replace the previous contractor in breach;
declined an offer from the contractor to deliver goods after the delivery date (the reasonableness of this would depend on the lateness of the offer and the consequences of late delivery);
declined an offer from the contractor to buy unsatisfactory goods back from the plaintiff at the contract price.

Practically, this means it may sometimes be necessary for a wronged party to continue working with the party in breach. At the minimum, a wronged party should remain open to working constructively with the breaching party, to identify ways for the breaching party, where possible, to make good the breach and /or for the parties to preserve the contract.

Liquidated Damages

Liquidated damages are a predetermined monetary value agreed by the parties within the terms of a contract to be payable upon a specific breach of the contract. In construction contracts, this is commonly used in the context of completion delays, where a set sum is payable by the contractor for every day the project is extended beyond the predetermined date for practical completion. Because they arise by contractual agreement, a party cannot claim compensatory damages for a breach which is covered by a valid liquidated damages clause.

In this way, liquidated damages can provide contracting parties with predictability and efficiency, especially for breaches which are easily provable and not improbable, as in the example of site delays. Often, liquidated damage provisions will enable a party to recover reasonable compensation from the party in breach without recourse to Court proceedings. Even where Court proceedings are unavoidable (for example, if there is dispute over the breach itself), the proceeding can be simplified by avoiding the need to quantify and prove the actual loss suffered.

However, care should be taken when negotiating liquidated damages clauses to ensure that the agreed value of reflects a ‘genuine pre-estimate of the loss’ anticipated in the event of the specified contractual breach. If the value of liquidated damages is not a genuine pre-estimate of losses, the clause will be deemed to be a penalty clause, it will be rendered void and unenforceable.

Common examples of penalty clauses include:

in the case of a failure to pay, if the liquidated damages sum exceeds the amount originally payable;
if a single lump sum value is specified on the occurrence of multiple different contractual breaches, of which some breaches are serious, and others are trifling;
where the sum of liquidated damages or interest due for all amounts owing under the contract increases upon default; or
otherwise, any sum of liquidated damages that grossly exceeds the losses likely to be suffered because of the breach.

Where a liquidated damages clause is deemed void and unenforceable, a wronged party would be entitled to claim compensatory damages as discussed above.

Common Damages Claims in Construction

Value of the contract

Where a contract has been unlawfully terminated by the principal, the contractor will generally be entitled to seek damages from the principal for the profit the contractor would have made on the remainder of the contract.

Costs associated with hiring a new contractor

Where a contractor has repudiated or unlawfully terminated their contract, the principal may need to source a replacement contractor at short notice. This can result in a contract that is more expensive than one negotiated through a time-consuming competitive tender process. Often, there may also be a duplication of costs already incurred as the new contractor will need to develop their own project management plans, safety plans, and other compliance documentation which would have already been paid for at the commencement of the terminated contract. In these circumstances, the principal would generally be entitled to claim:

the value of any mitigation action, plus the amount already paid under the terminated contract and the amount required to complete the project with the replacement contractor;
less the total amount the principal would have paid to complete the project under the terminated contract had it been duly performed.

Essentially, the principal will generally be entitled to any amount that it costs the principal to complete the project, which exceeds the original cost to complete the project under the terminated contract.

Work otherwise the responsibility of the contractor

If a contractor fails to perform an obligation under the contract within a reasonable or prescribed time, a principal may need to take urgent action to avoid or mitigate any losses (including, for example, urgent work to protect the project, people or third-party property).

However, close attention must be paid to the terms of the contract. Often, contracts will expressly detail the scope of a principal’s right to perform the contractor’s obligations where the contractor has failed to perform them in breach of the contract, and to deduct the cost of that performance from amounts payable to the contractor. Such clauses will usually include time and notice requirement to enable the contractor a reasonable opportunity to remedy the breach first. If a principal does not comply with these time and notice requirements before commencing the work, they may forfeit their right to recover the costs of that work.

Where the contract is silent on this issue, the principal may still have a right to undertake such urgent work under the mitigation of loss principle, which is discussed above, provided that the contractor has been provided with a reasonable opportunity to remedy the breach themselves.

Delays beyond the date for practical completion

Compensation for losses incurred by the principal because of delays to practical completion are commonly provided for in the form of a liquidated damages clause, as discussed above.

In the absence of a liquidated damages clause a principal would be entitled to claim for actual loss suffered because of the delayed practical completion. This most usually involves interest and other costs associated with prolonged financing of the project. Where the principal is liable to a third party to hand over the project on a certain date, the contractor could potentially be liable for amounts payable by the principal to the third party for breach of that third-party contract, subject to the common law rules relating to remoteness of the consequential loss (discussed above), and any contractual terms which operate to indemnify, limit or exclude liability.

It is important to note that construction contracts commonly include provisions allowing for certain qualifying delays (such as prolonged inclement weather) and otherwise granting the contractor a right to request to extend the date for practical completion. Before claiming damages for delayed practical completion (whether liquidated or actual damages), principals should ensure that they have taken account of any applicable qualifying delays and/or any extensions they have consented to which validly extend the date for practical completion beyond what is specified in the original contract.

Considerations when Claiming Damages

Maintain clear records

Parties should maintain clear documentary records which could help to prove the breach of contract and any losses flowing from it. This could include correspondence, contractual documents, site photos, invoices, receipts, timesheets and work logs.

To increase the reliability of documentary records, care should be taken to protect the original metadata of documents. Metadata can show (amongst other things), when a document was first created or edited which can help to prove that a document was a contemporaneous record and not created at a later date to support a claim.

It is also useful to keep a record of which personnel were involved in preparing key documents as it may be necessary to ask questions or take evidence from them later. This is especially important with handwritten records or spreadsheets with extensive data sourced from other documents.

Lastly, adopting clear and consistent naming conventions and version control of documents will greatly assist your legal team (and consequently save you money in legal fees) should the matter proceed to litigation.

Carefully review the contract

It is not uncommon for contracting parties to be unhappy with each other’s performance without that performance amounting to an actual breach of contract. This will depend on the individual circumstances of your issue and the terms of your contract.

As such, any party considering a claim for damages should first carefully review the contract to determine if and how the contract has been breached. This includes assessing the express terms of the contract to determine what the other party was obligated to do, or refrain from doing, and comparing this against their conduct. Don’t forget to consider other clauses within the contract that may provide exceptions to that obligation.

If you consider that a breach of the contract has occurred, the next vital step is to review the contract to determine what rights and options are available to you in response to that specific breach. Different rights may arise depending on whether the breach is of a minor nature or a fundamental term of the contract.

Assess your losses

To receive more than nominal damages, you must have suffered a loss that can be quantified and is able to be remedied by an award of money. At an early stage you should evaluate what losses you think you have incurred, or that you are likely to incur, because of the identified breach.

If any of those losses are consequential rather than direct loss, you will then need to check whether consequential loss is limited or excluded under the contract. The contract may also include monetary caps on the amount of damages you are entitled to claim for certain events, or an agreed liquidated damages sum.

Mitigate your losses where appropriate

Having assessed your actual or anticipated loss, you should consider if there are any reasonable steps which could mitigate those losses.

Even where you have a legitimate claim, there is a risk the other party might not have the financial resources to pay an award of damages. As discussed above, you might also lose your right to claim compensation for loss if it was within your control to avoid it. For this reason, the general rule is to protect your interests as you would if you had no recourse against the other party. However, you should consult the contract and talk to the other side (see below) before taking any significant unilateral action.

Ensure to keep records of any expenses you incur in mitigating losses, as you are entitled to claim them later as damages.

Engage with the other side

The contract may specify steps that must occur before you are entitled to enforce your rights under the contract – for example, by lodging a notice in a certain form, to a certain person, or within a certain timeframe, usually to enable the other party an opportunity to remedy the breach.

Even in the absence of formal contractual requirements, it is prudent to reach out to the party to provide notice that you consider them to be in breach of the contract and what they need to do. For example, it may be appropriate to request that they:

provide an explanation or response;
remedy the breach;
make good any loss that you might have suffered, or pay you a sum of liquidated damages where applicable; and/or
take action which could help mitigate your losses.

Always ensure you include a specific and reasonable time frame by which you expect them to comply with any request.

While some issues are especially time sensitive, it is generally always a good idea to make a reasonable effort to resolve issues constructively. Litigation is time consuming and expensive and, as noted above, unreasonably denying the other side an opportunity to remedy their breach could limit the damages which you can claim.

Determine the status of the contract

Notwithstanding a breach by one party, the starting position is that both parties’ obligations under the contract continue unless and until the contract is terminated. It is therefore important to determine the status of the contract following a breach and understand your rights at each stage, which will usually vary according to the nature and significance of the breach. The most common scenarios are discussed:

Suspension of performance

The contract may provide that certain contractual breaches entitle the other party to suspend performance of their own obligations until the breach is remedied. It will usually be necessary to give notice to the other side that you intend to suspend performance in this way.

Inability to comply

A breach by the other party may prevent you from performing your own obligations under the contract, either at all or by the due date. There are principles at common law that would prevent the other party succeeding in a claim against you for your own breach if it is caused by their own non-performance. However, you should always communicate your expected non-performance and the reason for it and keep records of same. The contract may also have terms relating to this scenario which you should consult. For example, even if the other party’s breach causes a delay in your own performance, it may still be necessary to formally ‘request’ an extension on that basis.

Repudiation and termination

Where one party has made it clear to the other party that they are unable, or have no intention, to honour their primary obligations under the contract this is called repudiation. This usually entitles the other party to terminate. Certain fundamental breaches may also provide a right to terminate the contract. In either event, it is usually still necessary to give notice to the other side that you are terminating the contract. We strongly recommend seeking legal advice before purporting to terminate a contract as the right to terminate can be nuanced and an unlawful termination may give the other party a right to claim their own damages against you.

Importantly, unless one of the above exceptions apply, you will be required to continue to perform your own obligations under the contract notwithstanding another party’s non-performance, and your obligations will continue until the contract is lawfully terminated.

Determine whether any dispute resolution provisions apply

Construction contracts commonly include dispute resolution provisions which need to be complied with before litigation can be pursued. For example, a contract may require the parties to attend mediation at least once within a certain timeframe after the breach before the plaintiff can pursue litigation. If you do not comply with dispute resolution provisions, the Court may adjourn your case until such time as the dispute resolution provision is complied with.

Conclusion

Damages are the end goal of almost all legal disputes over construction contracts, so it is important for both principals and contractors alike to understand the fundamental principles and mechanisms which govern claims for damages.

The protect your position you should maintain clear records of any contractual breach and the losses flowing from that breach. When contracts don’t go according to plan it is easy to focus on the other party’s conduct, however you may still be required to continue to perform your side of the contract and/or to work with the other side to remedy the breach and resolve the dispute. Both parties should therefore ensure that they have a clear understanding of their own obligations under the contract including their rights and obligations in response to a breach, how liability for losses is distributed, and the processes to be followed to resolve any disputes that arise.

Please don’t hesitate to contact us if you have any queries about damages claims, or construction contracts generally.