- Liquidated Damages and Penalties
a)Is the concept of liquidated damages (LD) / penalties accepted under the applicable law?
Yes, the concept of liquidated damages/penalties is accepted and is laid down under section 74 of the Contract Act 1872 which states:
“When a contract has been broken, if a sum is named in the contract as the amount be paid in case of such breach, or if the contract contains any other stipulation by way of penalty, the party complaining of the breach is entitled, whether or not actual damage or loss or proved to have been caused thereby, to receive from the party who has broken the contract reasonable compensation not exceeding the amount so named or, as the case may be, the penalty stipulated for.”
b)Is there a distinction between Liquidated Damages and penalties (fines) under applicable law, if yes what is the difference?
Liquidated damages are recognized as a genuine pre-estimate of damages whereby which the parties agree a certain fixed specific amount so that in case the breach or actual loss occurs the parties will not have to face hardships in later determining/calculating actual damages accrued. It is the damage/loss accrued that one party claims from another as a result of the breach
Penalty may more so be considered as a burdensome character that operates as a stipulation in a contract as in terrorem(a warning) so as to drive the person to fulfil the contract (PLD 1975 Karachi).For example in case of non-payment or late payment “A” agrees to pay “B” $350 if “A” fails to pay $250 by certain date, then here the stipulation is in the form of penalty .
Notwithstanding the above the Legislature has enacted a uniform principle applicable to all stipulations naming amounts to be paid in case of breach and stipulations by way of penalty. In every case the Court which tries the suit is now basically not bound to award more than the “reasonable compensation” that is not exceeding the amount named. Therefore it is not necessary for Courts in Pakistan to decide whether the amount fixed in contract is fixed as liquidated damages or as penalty because either way the Courts will determine reasonable compensation.
c)Are liquidated damages recognized as a valid and enforceable express remedy?
Liquidated damages are recognized as valid and enforceable express remedy however, the threshold is that positive evidence has to be shown to the Courtthat proves actual loss was suffered by the party claiming the damages .Mere fixed amount stipulated as liquidated damages would not be recoverable if the quantum of actual loss was not proved ( Saudi Pak Industrial and Commercial Investment Company (Pvt.) Ltd. v. Allied Bank Limited 2003 CLD 596).
d) What relation is there between LDs and actual damages? Can LDs and actual damages be claimed independently from each other and if so to which extent? If they can, is there special language that should be used to ensure the Employer can either claim LDs or actual damages?
As per the wordings of the section 74 of the Contract Act reasonable compensation has to be awarded whether or not loss is proved.However, the Courts in Pakistan award liquidated damages generally only if the actual loss or damage suffered is proved therefore the awarding of liquidated damages on account of proving the actual damage goes hand in hand. Both cannot be claimed independently.
The Higher Courts in Pakistan have been adamant on the fact that the liquidated damages required positive evidence to show that such actual loss was suffered by the party claiming the damages and mere fixed amount stipulated as liquidated damages would not be recoverable if the quantum of actual loss was not proved.
e) What is the test for the enforceability of liquidated damages?
The test for enforceability of liquidated damages is that positive evidence has to be shown that actual loss was suffered by the party claiming the damages. A mere fixed amount stipulated as liquidated damages would not be recoverable if the quantum of actual loss is not proved. The Court will not base award of claiming liquidated damages solely on breach of terms of contract/agreement.Non-awarding of claim of liquidated damages, which is solely based on the breach of terms of an agreement, is fully justified in circumstances (United Bank Limited v M. Ismail & Company 2006 CLD 394)
f) Are there limitations that could possibly render LD-clauses invalid?
Not proving the actual loss or damage suffered can limit the applicability or scope of the LD clause but will not render the very clause completely invalid.Section 74 of Contract Act, 1872 provides that it is for the Court to determine what would be the reasonable compensation not exceeding the amount named in the contract to be awarded for breach of a contract (National Bank of Pakistan vMarhaba Textile Ltd -2007 CLD 508 Karachi).
Where the person claiming the damages has neither shown nor indicated in any document as to how the liquidated damages have been calculated and how the liquidated damages claimed are reasonable compensation, such claim is contrary to the provisions of Contract Act, 1872 and the same is rejected by the Courts (National Bank of Pakistan v West Pakistan Tanks Terminal Ltd -2000 CLC 896-Karachi).
It is important to note that the sum named in the contract is not conclusive evidence of damages, and if there is other evidence or circumstances showing that it was excessive, the court will not consider itself to be bound by it. This can be considered as limitation of a LD clause, but does not render it invalid at the same time.
g) Are liquidated damages automatically considered an exclusive or sole remedy? If not, is there special wording that should be used to ensure liquidated damages are the exclusive remedy for a particular breach of contract?
Liquidated damagesare not the only sole remedy. The parties can frame the clause in a manner that will enable LD’s being a sole and exclusive remedy. For specific formation of remedy in the shape of liquidated damages the wordings can be as follows:
“If a Supplier delays delivery of goods/services beyond the stipulated delivery date and is unable to seek timely extension in the delivery date through a written request, is unable to convince “the company (client/employer)” that the extension being sought in the delivery date is due to reasons beyond the Supplier’s control, the Supplier is liable to pay to “the company”, Liquidated Damages @ 3% per month or part thereof up to a maximum of 8% of the contract value.”
h)May a party who contractually agrees to pay liquidated damages if it fails to meet certain deadlines refuse to pay liquidated damages in case it can prove that the Employer did not suffer any damages due to that party’s fault?
The onus to prove that damages are suffered is on the person claiming them. In this case it may be the Employer (client). Therefore it is the Employer (client) in this scenario who has to show evidence with regards to actual loss or damage suffered. In case Employer (client) is able to show the above then the contractually agreed amount or reasonable compensation as the court may deem fit shall be awarded even in case of agreement to pay LD’s.
It is important to note that the person claiming such liquidated damages is under obligation to bring sufficient material on record in order to prove that he had suffered so much of losses. Without proving the actual loss, even fixed amount stipulated as liquidated damages does not automatically become payable (Allied bank of Pakistan Limited, Faisalabad v Ashisha Garments 2001 MLD 1955-Lahore)
i)Are penalties recognized and enforceable?
For a sum to be treated as penalty there must be an amount to be paid in case of a breach of an antecedent promise .The question whether a clause in a contract provides for liquidated damages or for a penalty strictly so called in the sense of punishment irrespective of the damage sustained is a question not of words but of substance and of things. Therefore this is a question of construction for the courts alone. For example where in a compromise “A” agrees to pay “B” $350 ,if “A” fails to pay $250 by certain date, then here the stipulation is in the form of penalty.
The Courts will look at the intention, position of parties in the contract, circumstances and facts of the case to determine the enforceability of penalty.
j)What is the test for the enforceability of penalties?
A penalty includes a sum fixed in terrorem. In such cases where sum has been stipulated as in terrorem to work as a deterrent to compel a party to fulfill the main contract and no certain data is to be found for the determination of a reasonable compensation then Court will look at the nature of the transaction, the position of parties at time of bargain and due or undue advantage that might result to the parties by enforcement of penal clause (PLD 1961 Karachi 305).
If Court calculates that the amount stated or agreed upon either as LD or penalty in contract is not same as actual damage suffered, then it will reduce it to reasonable sum. This shows that Court will not allow an amount in excess of already agreed capped amount or deemed fit so the amount even as a penalty will be reduced to a reasonable as per the reasonable compensation yardstick that the Court applies when assessing damages.
The Courts have on many occasions been adamant on the point that where contract contains any stipulation by virtue of which any specific amount or a penalty is payable when a breach of contract is committed, then the party complaining of the breach is entitled to receive from the party committing breach of contract, not the amount or penalty specified therein but reasonable compensation not exceeding the amount mentioned in the contract .
Reasonable compensation is a question of fact and the party who claims such compensation must prove that fact which could only be done by producing evidence or by placing on record documents to prove reasonable compensation in the circumstances of the case where the law permitted or requesting the Court for permission to adduce evidence (National Development Finance Corporation Limited v Moona Liza Fruit Juice Limited -1999 YLR 500- Karachi)
k)Are penalties considered a remedy for damages or can the Employer claim penalties and actual damages? If the latter is true, is there special language that should be used to ensure the Employer can either claim penalties or actual damages or that at least actual damages can only get claimed as far as they exceed the amount of penalties for which the supplier is liable?
The Courts must proceed according to what is the real nature of the transaction involved and the mere use of word “penalty” on the other side or “damages” on the other would not be conclusive as to the rights of the parties. In deciding this Courts will look into the intention of the parties as evidenced by their language and circumstances of the case, which however must be taken as w whole and viewed as at the time when contract was made.
The Act itself provides two forms of compensation .Section 74 of the Act specifically deals with a contract which provides the amount of compensation in the form of penalty or liquidated damages in case of breach. Therefore penalty is considered a remedy for damages. Secondly the Employer can claim both penalties and actual damages. The wordings of a penalty clause will go as follows:
“ If I fail to pay agreeably to the conditions written, then the remission made by you under the amicable settlement is not to hold good”
Any statement that holds a burdensome or oppressive character so as to make the other party fullfill the contract then such stipulation is a penalty. The sum in this case is fixed in in terrorem.
It is important to note however that test of determining whether a stipulation is an LD or a penalty is that of reasonable compensation which is a question of fact and the party who claims such compensation must prove that fact which could only be done by producing evidence or by placing on record documents to prove reasonable compensation in the circumstances of the case where the law permitted or requesting the Court for permission to adduce evidence.
The wording may be as follows:
“The Parties agree that any liquidated damages payable under this Section ___ shall be the __X___sole and exclusive remedy against the _Y company______in respect of the matters to which such liquidated damages relate. TheY company shall pay the X as liquidated damages an amount equal to ten percent (10%) of the difference between the Declared Available Capacity and Revised Declared Available Capacity prevailing…The Parties agree that the amounts of liquidated damages provided are in lieu of actual damages and are the Parties’ reasonable and genuine estimates for the actual damages and/or losses that may reasonably be anticipated from such failures in respect of such matters, and do not constitute a penalty.”
l)Are penalties automatically considered an exclusive or sole remedy? If not, is there special language that should be used to ensure penalties are the exclusive remedy for a particular breach of contract?
As mentioned earlier above a penal clause will have some onerous words included. It will depend on how the words of the clause are framed to ensure penalty as a sole remedy. If a buyer agrees that in case of default of payment to the seller, he (buyer) will be liable to pay $20 as damages to the seller or vice versa. Then in such circumstances the Court after examining the circumstances at hand will hold that such sum was in the nature of a penalty. The Courts however are reluctant in awarding excessive/exorbitant penalty and generally penalty is not enforceable. Again the focus will be on substance and of things not just on words or forms of speech.
m)Is there any special wording language that should be used in a contract to ensure the general enforceability of a liquidated damages or penalty provision?
The special wording language to be used may be:
“ The amount $5000 is calculated by the parties as representing the likely daily loss for delay in delivery of machinery/equipment in achieving specified completion date of project and are reasonable and constitute liquidated damages and are not a penalty”
OR
“If a Supplier delays delivery of goods/services beyond the stipulated delivery date and is unable to seek timely extension in the delivery date through a written request, is unable to convince “the company” that the extension being sought in the delivery date is due to reasons beyond the Supplier’s control, the Supplier is liable to pay to “the company”, Liquidated Damages @ 3% per month or part thereof up to a maximum of 8% of the contract value.
n)Are there circumstances where a party can collect actual damages related to a violation/breach of contract, despite a liquidated damages/penalty provision stating liquidated damages/penalties as an exclusive remedy for such breach?
There is no possibility of double recovery where there is already an express provision stating a certain percentage or amount of liquidated damages/penalty payable at the time of violation or breach of contract .
- Performance Guarantees
a)Does local law provide for any particular remedies for failure of equipment to perform in a certain way or per contract requirements? If so, can such remedies be disclaimed?
Performance guarantee is a guarantee given by the supplier to the buyer which is outside from the main agreement or supplemental agreement and one which is separately enforceable as a remedy .It’sa separate guaranteeexecuted at the time of contract whereby the guarantee is given by the supplier to the (Employer/client) buyer. Such guarantee is independent and autonomous in nature.
What makes a performance guarantee different from a usual term of a contract is the ability to encash it incase work does not happen in a certain way. For example, it is similar to that of an irrevocable letter of credit that must be honoured according to its terms irrespective of the fact whether supplier is in default or not. Performance guarantee can be encashed without reference to the actual contract or agreement (including supplemental agreement).
This is different from a term of the contract stipulating damages to be paid in case of failure of equipment to perform in a certain way. Performance guarantees is a promise made that either a service lives up to certain expectations, or that a service or product will continue to perform well over a stated time period. It is guarantee for due performance of contract by parties. Such guarantee involves an amount that gives the buyer a separate right to encash at the time of failure to meet certain requirements. This in itself is a separate remedy whereby which the buyer can encash the guarantee without the need to go to court or the supplier. Such guarantee once given cannot be disclaimed. The buyer does not need to prove that he has suffered actual loss in order to encash performance guarantee. This remedy cannot be disclaimed unless there is fraud of the beneficiary (PLD 2003 SC 191).
Where such guarantee had been furnished as per requirements in contract and supplemental contract, under specific terms and conditions, same could be encashed without reference to agreement including supplemental agreement( ToyoMenka Kaisha Ltd, Tokyo, Japan v Ferro Alloys Pakistan Ltd -1988 CLC 418).
So far as the definition and import of the Performance Guarantee is concerned it is sufficient to say that it is a new type of Guarantee introduced for large and mostly international contracts. It is independent and autonomous in nature generally but its import and scope can differ from case to case according to the facts of each case and according to the wording of Performance Guarantee furnished therein. It will be absolutely independent if the encashment is left to the exclusive option of the beneficiary as a sole Judge of the breach and loss but if the wording is different and admits of the determination of the point as to who breached the contract and as to what was the resultant loss on account of the said breach then the Performance Guarantee will not be available for encashment solely on the option of the beneficiary.
b)Are liquidated damages considered a valid remedy for failure to meet performance requirements set forth in a contract if so agreed?
Liquidated damages are considered a valid remedy for breach of a term of a contract for which positive evidence has to be shown to prove that actual loss was suffered. If a term is stipulated in manner that encompasses the fact that if machinery fails to meet performance requirement then damages will accrue then liquidated damages may be treated as remedy. This is not to be confused with performance guarantee concept. The afore-mentioned points are re-iterated.