DAMAGES IN CONSTRUCTION CONTRACTS

by Mr Chan Kheng Hoe, Head of Construction Law, Chong + Kheng Hoe

Damages is simply the compensation that a contracting party claims against the other contracting party for breaches of contract. In construction contracts, the nature of damages would ordinarily be the additional costs incurred.

These additional costs may arise from a multitude of factors including variations, delays, disruption, acts of prevention by the Employer, acceleration costs, design issues, suspension and termination of contracts. The damages claimed may be the actual or approximate costs suffered, and sometimes include consequential and indirect costs including loss of profits.

Entitlement and valuation

To succeed in a claim for damages, there must very simply be: (a) entitlement to the claim; and (b) proper valuation of the measure of damages.

Whether one is entitled to make the claim would oftentimes be a matter of interpretation of the contract. There must be some form of breach of contract before a claim for damages arises. Of course, there can be arguments of breaches of “implied terms” of contract as well, meaning that the breach is not provided for in the contract, but it arguably should have been there. A claim for breach of an implied term is not as direct, as it would depend on whether the tribunal or judge agrees that such a term should be implied in the first instance.

A term would only be implied if it is a “no-brainer”, or it can be shown that such a term is so customary that there is no need to even refer to it. As the construction industry has well-developed standard forms of contracts, it is rare for terms to be implied. After all, parties could have used a different standard form of contract which provides for such terms if they so wished.

Need to prove damages

Once entitlement (or liability, in legal terms) is established, there is usually a need to show how much damage was suffered arising from that specific entitlement. In other words, the damages sought need to be proven and tied to the breach.

However, it has also been recognized that construction could well be the management of a million moving parts. Sometimes, this makes it difficult to prove the actual damage suffered from one specific breach of contract when there are a myriad of events happening at the same time. Under such circumstance, some parties may opt to make a total cost claim, or a global claim. A total cost claim is one in which the damages sought are not specifically related to one specific breach but is calculated on a global basis by comparing the contractual price as opposed to the as-built price.

Issues with total cost claims

If a contractor is mounting a total cost claim, it is important for the contractor to show that the entire additional cost is due to the fault of the employer, and none of the additional cost was caused by the contractor itself.

Mounting a total cost claim in a situation where there are concurrent faults may lead to a dismissal of the claim if the tribunal or judge is unable to properly assess as to which part of the claim arises from the contractor’s fault and which part arises from the employer’s fault.

Of course, a contractor could try to persuade the tribunal by acknowledging its own faults in the process to make an adjustment to the total cost claim. Whether a tribunal agrees to apportion the claim or otherwise is not an absolute certainty.

Variation claims

Obviously, variations that are properly instructed and certified would not raise any issue. However, there are oftentimes claims for variations which are neither properly instructed nor certified.

In so far as variation claims are concerned, a contractor would have to prove: (a) entitlement to the variation claim; and (b) valuation of the variation claim. Whether a certain work qualifies to be considered as a variation is oftentimes a matter of interpretation of the contract. Is it already something included in the main contract works or so essential to the main contract works that it must be deemed to be included? Do the bills of quantities take precedence over the construction drawings, or vice versa? Is there some form of instruction, and is that instruction valid?

If a work is properly considered to be a variation work, then the valuation of the variation would usually go by: (a) contracted rates for similar works; (b) adjusted contracted rates; (c) reasonable rates; or (d) cost-plus rates.

Delay related damages – liquidated damages

On the employer’s part, any delay to the works may entitle the employer to claim liquidated damages. The employer would have to comply with the contractual pre-conditions for the imposition of liquidated damages. In the context of the PAM form which is the most commonly used standard form of contract, the architect would have had to issue a certificate of non-completion before liquidated damages can be triggered. The failure of the architect to issue a certificate of non-completion, or the act of the architect to issue a certificate on a belated basis, will lead to arguments as to whether liquidated damages can be imposed.

Of course, if a contractor delays the project, the employer is still entitled to claim for damages to be proven even if the architect fails to issue a certificate of non-completion. The employer merely faces a more uphill task proving actual damages, as opposed to liquidated damages. This is because liquidated damages are already fixed by contract, subject to any arguments by the contractor that the liquidated damages are unreasonable.

The contractor’s argument of unreasonableness of the liquidated damages must be tied to the issue of entitlement and reasonableness to impose the damages, and not so much the issue of quantum because quantum is contractually agreed. In any event, the stipulation of liquidated damages constitutes the maximum damages claimable by the employer for the contractor’s delay.

Delay related damages – prolongation costs

Conversely, a contractor may also claim against the employer for prolongation costs when the project is delayed by the employer. If a contractor can prove that the prolongation was caused by the employer, the contractor may be entitled to claim for extended preliminaries and any actual costs incurred arising from such delay such as extended rental of equipment and machineries, extended premium and fees paid for insurance and bond, additional labour costs.

In many cases, the contractor also tries to claim for additional overheads and head office expenses. In order to succeed in such a claim, the contractor would need to show that it was unable to mitigate such additional expenses by its inability to take on other work. As a result, the overheads and head office expenses had to be allocated to the project because the contractor was compelled to be on standby, for instance.

If entitlement to additional overheads and head office expenses are allowed, it is common for contractors to rely on a formula approach to claim such expenses. The common formulae used are the Eichleay, Hudson and Emden formulae, although variations of such formulae definitely exist.

With the fluctuation in material prices experienced recently, prolongation cost claims can be very substantial. A more controversial claim would be a claim for currency fluctuations when materials or parts of the contract is sub-contracted in another currency. Normally, a claim for currency fluctuations would be uphill as contracts are denominated in one particular currency, and therefore the assumption is that the contractor has assumed the risk of currency fluctuation.

Delay related damages – acceleration costs

An employer oftentimes instructs the contractor to accelerate its works when the works are in delay. The critical question is to consider who caused the delay in the first place.

If the delay is caused by the contractor, then such acceleration is in fact an attempt to catch-up with the works programme. Any attempt to catch-up cannot be charged to the employer. On the contrary, the employer may choose to appoint third parties or increase the manpower for the project at the costs of the contractor to facilitate the catch-up.

However, if the delay is caused by the employer, then the acceleration is chargeable. By right, the contractor may refuse to accelerate unless the employer agrees to terms. Such terms may include agreed costs for the acceleration. Bear in mind that acceleration will also cause disruption in the works programme.

When the contractor and employer cannot agree as to whose fault caused the delay in the first place, a contractor would be prudent to accelerate the works even if the employer refused to agree to terms. The contractor can subsequently claim for constructive acceleration, i.e. acceleration that was caused by the employer’s delay and implemented despite the employer refusing to agree to costs. It is deemed that the acceleration was instructed and chargeable by reason of the employer having caused the initial delay.

Causation of delay

Entitlement to liquidated damages on the part of the employer or prolongation costs on the part of the contractor is closely tied to the causation for the delay in the works. In simple terms, who was responsible for the delay?

The answer, more often than not, is that both parties were responsible. Concurrent delays are a common occurrence in construction projects, and have led to much argument before tribunals and courts. Whilst multiple theories have been promulgated, at the end of the day, it still boils down to the issue of causation. Even in a situation where both parties have concurrently delayed the project, the contractor must still demonstrate to the tribunal that the employer’s delay in fact (and not merely in theory) impacted the work progress.

This is especially important when the contractor is in culpable delay first. Take for example a contractor who is delayed due to lack of manpower. Subsequently, there was inclement weather that set in. The inclement weather can be said to be a non-factor because the contractor had no manpower to work anyway.

Therefore, a contractor who has fallen into culpable delay must immediately take steps to bring its own cause of delay to an end. If the contractor can demonstrate, in the example above, that it has managed to secure manpower, then and only then would the inclement weather be construed as a delaying event.

Disruption and loss of productivity claims

Disruption by the employer or by parties for whom the employer is responsible may lead to a loss of productivity. The most common example would be a situation where multiple contractors are working on site. Delays by another contractor may disrupt the work flow and access to site for the contractor, leading to a loss of productivity.

There is a need for the contractor to maintain good records in order to claim for loss of productivity. The loss of productivity is usually claimed by reference to the measured mile. This means that the contractor must have records to show its own progress under non-disrupted conditions. If the contractor can consistently its progress under non-disrupted conditions, then it will have a good claim for loss of productivity when its progress is disrupted.

Without proper records, it would be an extreme difficulty to prove any such loss of productivity. A contractor seeking to claim for loss of productivity must also bear in mind that the showing of productivity records may also show the shortcomings of the contractor’s own rate of works.

Termination related claims

If a contract is terminated, then the first question to be addressed is whether the termination is lawful or otherwise. Of course, there are contracts which allow the employer to terminate without reason. Under such contracts, it would be likely that the contractor cannot claim for damages arising from termination.

If a contract is lawfully terminated by the employer due to breach by the contractor, then the employer will have to appoint a new contractor to replace the terminated contractor. The additional costs of the new contractor and all related costs arising from the termination (for example, additional consultants’ fees, re-tendering exercise costs, etc) may be claimed against the defaulting contractor.

If a contract is lawfully terminated by the contractor, on the other hand, the contractor may be entitled to claim: (a) payment for all works carried out up to date of termination; and (b) loss of profits for balance of the contract. These would be similar claims that a contractor can make where the contract is unlawfully terminated by the employer.

Conclusion

For any claim for damages, it is crucial that the contractor proves its: (a) entitlement to the claim; and (b) valuation of the claim. There must be a causal link from the breach of the contract by the employer leading to the actual claim by the contractor. In a total cost claim, the contractor needs to show that the entire claim is attributable to the employer and not to itself.

At the end of the day, the award of damages is not an exact science. The tribunal or judge will endeavour to put the non-defaulting party into the position as if the breach did not happen. Claim for damages, especially general damages, is at best a guesstimate. However, a contractor can assist the tribunal or judge to make a better guesstimate if it has maintained proper records.