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24/10/2014

It is fairly common for parties to agree liquidated damages (LDs) to be used for breach of contract in failing to complete on time, or breach of contract in failing to pass specified performance tests.

However in Bluewater Energy Services BV v Mercon Steel Structures BV and others [3] the parties to a subcontract agreed LDs in connection with a key personnel clause.

The works related to the design, construction and installation of a tower based soft yoke mooring system as part of the development of an oil field in the Caspian Sea.

Under the sub-contract, the main contractor (Bluewater) was entitled to apply liquidated damages if the subcontractor (Mercon) replaced key personnel without obtaining the prior approval of the main contractor. The rate of LDs ranged from €20,000 for the HSE engineer to €50,000 for the project manager. The subcontractor replaced personnel without approval and then argued that the LDs were a penalty and so unenforceable.

The court upheld the validity of the clause – it was not a penalty. The judge considered that the key personnel were central to the successful performance of the contract and Bluewater’s ability to approve or disapprove of their replacement was an important safeguard for the proper performance of the contract.

In addition the judge did not consider the value of LDs to be unconscionable in terms of being extravagant or exorbitant. A key factor in this case was timing. Whether a contractual provision is a penalty or not must be judged at the date of the contract in question. At the time of entering into the contract the evidence showed that the parties had negotiated the LD rates and had considered the possible loss caused by disruption to the works by replacing key personnel.

LDs provide certainty to both parties in commercial relationships, and the courts continue to be reluctant to interfere with freedom of contract. It is therefore worth considering agreeing LDs for other types of breach under a contract, particularly if quantifying/proving the loss would be difficult after the breach. In adopting this approach, it is important to keep safe the contemporaneous evidence of discussions and calculations on how the LDs were settled upon, in case these need to be disclosed in the future to justify the amount.

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[3] [2014] EWHC 2132 (TCC)

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