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Paying the penalty - don't forget to check liquidated damages clauses when negotiating a deal
In the recent case of Unaoil Ltd v. Leighton Offshore Pte Ltd  EWHC 2965 (Comm) the Commercial Court rejected Unaoil’s claim for liquidated damages on the basis that the relevant clause was an unenforceable penalty. However, the Court held that the clause did not constitute a penalty at the time the contract was made, but rather it became such when the contract was amended. This is a departure from previous authority. It remains to be seen whether the judgement will stand, and whether or not it will be followed.
Leighton engaged Unaoil as a sub-contractor to provide construction, and other related, services in relation to an oil pipeline project in Iraq that Leighton was tendering for as contractor. The parties entered into a memorandum of understanding (“MOA”), which stipulated an all-inclusive price of $75 million for the project. The MOA provided that Leighton would pay Unaoil $40 million in “liquidated damages” if it did not adhere to the agreed terms. The MOA also required Leighton to make various advance payments, amounting to approximately US$12 million.
The MOA was subsequently amended, to the effect that Unaoil was to be paid a reduced price of $55 million for construction and marketing services in relation to the project (including a minimum marketing fee of $25 million), plus an additional percentage of any amount that Leighton received in payment above US$500 million.
Leighton was engaged as contractor, but failed to enter into a sub-contract with Unaoil, selecting another sub-contractor instead. Unaoil brought a claim for: (i) the advance payments, (ii) the liquidated damages and (iii) damages for loss of profit resulting from Leighton’s breach of contract.
The Court allowed the debt claim for the advance payments. In addition, the Court held that Unaoil was entitled to damages for loss of profit due to Leighton’s repudiatory breach. However, the Court’s assessment of the amount of damages for loss of profit did not exceed the amount of the advance payments. As Unaoil had conceded that it would give credit for the advance payments, the damages element did not impact on the aggregate amount awarded to Unaoil (approximately $12 million).
The most interesting aspect of the judgement related to Unaoil’s claim for liquidated damages. The Court said that the liquidated damages clause was or at least may have been a genuine pre-estimate of loss at the time the MOA was signed. However, when the MOA was amended and the contract price was reduced, the Court held that the figure of $40 million was “manifestly one which could no longer be a genuine pre-estimate of likely loss”.
It is accepted law that the question of whether or not a clause is a penalty must be viewed at the time the contract is made. This was one of Lord Dunedin’s propositions in the seminal case of Dunlop Pneumatic Tyre Co Ltd v. New Garage and Motor Co Ltd  A.C. 79, and has been followed ever since. Indeed, this principle formed part of the ratio in the recent Court of Appeal decision in El Makdessi v Cavendish Square Holdings BV and another  EWCA Civ 1539 (and was one of the reasons the Court of Appeal reversed the High Court’s ruling), a case cited by the Court in Unaoil. Justice Eder conceded that there was no authority for the proposition that the relevant date for ascertaining whether the clause was penalty was the date of the amendment of the contract.
It remains to be seen whether or not this decision will be appealed, but needless to say, Leighton will have some fairly persuasive arguments to put forward if it is. In the meantime, parties to commercial contracts and their lawyers should be mindful of the unintended impact of amending agreements, particularly where there is a change in price and the agreement provides for liquidated damages.
For more information, please contact Andy Moseby.