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If a construction contract has been drawn up in any sort of formal way, it is almost certain to contain a liquidated damages clause, fixing the amount that the contractor will have to pay if it fails to complete on time. There are two reasons for the popularity of such clauses. The first is that the contractor wants to limit exposure. To keep the building owner waiting for the building may involve huge expense that could be out of all proportion to the cost of the building itself, or at least to the profit that the contractor hoped to make.

The second reason comes from the other point of view. The building owner may find it difficult to prove the loss caused by delay, and it is therefore attractive to agree the figure in advance so that the pain of proving it all later is avoided.

Historically, the courts have been suspicious of liquidated damages clauses. It is a fundamental principle of the common law system that if there is a breach of contract, the person suffering the loss must prove what that loss is, and can recover only that amount. That is why the compensation is called 鈥渄amages鈥�. If the person claiming has not suffered damage, nothing is recoverable except a nominal sum.

This suspicion has led to the rule that if the court is persuaded that the liquidated damages clause has been included in the contract as a penalty for being late, rather than a genuine agreement about what the damages are likely to be in event of delay, the clause will not be enforced. That was set out in a 1915 House of Lords decision. Ever since, contractors have happily signed up to contracts with liquidated damages clauses, and when the inevitable delay occurs, the same contractors have argued that the clauses are unenforceable because they are in reality penalty clauses.

It may sound convincing to produce clever arguments showing that the figure claimed by reference to the stated rate per week for delay is substantially greater than the loss suffered, but these arguments miss the point. The court does not require the liquidated damages figure to be something like the actual loss. What it asks is whether the figure was a genuine estimate of the likely loss at the time that the contract was made. If it was, but circumstances changed so that the loss was substantially reduced, the clause is still enforceable.

It isn鈥檛 a bad idea for the employer to have a scrap of paper showing how he came to the figure for the weekly loss

This was all clarified by the privy council in 1993. A project in Hong Kong had involved several different contractors in separate contracts, each of which had complex liquidated damages clauses. If all of them came into play at once, it was argued that the total damages recoverable would be so huge as to indicate that the figures claimed were penalties. The court decided that if two commercial parties entered into an agreement for liquidated damages that appeared to have been carefully calculated and agreed, it would be wrong to intervene. Lord Woolf said that to strike out a liquidated damages clause was 鈥渁 blatant interference with freedom of contract, and can only be justified where there is oppression鈥�.

And yet people still think that it is worth arguing that the liquidated damages clause in a contract is a penalty and should not be enforced. A recent example came up before Judge Cockroft in the Technology and Construction Court in Leeds. North Sea Ventilation was trying to get out of such a clause in its contract with Consafe Engineering (UK). The figure payable was one that increased gradually in proportion to the seriousness of the breach. The judge thought that such a clause was 鈥渃ommonplace鈥� and that there was no oppression. On that basis he decided that the clause was enforceable.

It is clear that a contractor trying to knock out a liquidated damages clause has an uphill battle. Still, it isn鈥檛 a bad idea for the employer to have a scrap of paper at the back of the file somewhere with a simple calculation showing how he came to the figure that was put in for the weekly rate. It can then be shown that there really was an exercise in estimating what the loss was likely to be. You never know when it may come in handy.

John Redmond is head of construction at solicitor Osborne Clarke in Bristol