businessman showing red card

Liquidated and ascertained damages (LADs) clauses are sometimes challenged by those who have to pay them, on the grounds that they are penalty clauses, rather than genuine pre-estimates of damage. If a LADs clause is deemed to be a penalty, then it will be unenforceable.

Whether a LADs clause is a penalty will be assessed at the time of the contract. But what happens when the parties enter into a contract with a LADs provision, but then agree to vary the contract, without reviewing the LADs? Will the LADs still be viewed as a genuine pre-estimate of damage?

The murky world of Iraqi oil exploitation provided an answer to this question in a recent case*. The claimant had entered into a Memorandum of Agreement with the defendant, by which the claimant would undertake sub-contract works in respect of the construction of an oil pipeline in Iraq. Both parties expected that the defendant would be awarded the main contract by the employer, the South Oil Company. They also assumed that the South Oil Company would approve the claimant as sub-contractor. Under the Memorandum of Agreement, the claimant agreed to do the sub-contract works for the all-inclusive price of $75million.

As it turned out, the defendant was awarded the main contract, but the South Oil Company did not approve the claimant as sub-contractor. In an effort to win the sub-contract, the claimant reduced its all-inclusive price to around $55million. Despite this, they were still not approved and the sub-contract was awarded to another company.

Under the Memorandum of Agreement LADs, of $40million were payable by the defendant if it did not adhere to the terms of the Memorandum. However, whilst the defendant accepted that it had not adhered to the memorandum, it argued that the LADs provision was a penalty.

The Court found that whilst the LADs of $40million would have been a genuine pre-estimate in light of the original all-inclusive fixed price of $75million, it was not in light of the revised fixed price of $55million. The revised fixed price was the relevant figure and thus the LADs clause was a penalty. It was therefore unenforceable.

The clear lesson from this is that if the parties decide to vary the terms of the contract, they should always look at the effect that this may have on the LADs provisions.

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*Unaoil Limited v Leighton Offshore Offshore Pte Ltd [2014] EWHC 2965 (Comm)

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This blog is intended only as a synopsis of certain recent developments. If any matter referred to in this blog is sought to be relied upon, further advice should be obtained.